1. Calculation of Incremental Initial Investment
Tax on sale of old machine = (Sale price - Book Value)*Tax rate = (75000 - 70000)*30% = $1,500
Net Realizable Value of old machine, if sold today = 75000 - 1500 = $73,500
Incremental Initial Investment = Purchase price of old machine - Net Realizable Value of old machine = 150000 - 73500 = $76,500
2. Calculation of Incremental Subsequent Annual Cash Inflow
Depreciation using straight line = (Cost - Salvage Value)/Number of years of useful life
Depreciation on old machine = (70000 - 10000)/5 = $12,000 per year
Depreciation on new machine = (150000 - 40000)/5 = $22,000 per year
Incremental Depreciation = 22000 - 12000 = $10,000
Savings in cash operating cost = 20000 - 12000 = $8,000
Incremental Subsequent Annual Cash Inflow = (Savings in cash operating cost - Incremental Depreciation)*(1 - Tax rate) + Incremental Depreciation = (8000 - 10000)*(1 - 0.30) + 10000 = $8,600
3. Incremental Salvage Value
Incremental Salvage Value = Salvage value of new machine - Salvage value of old machine = 40000 - 10000 = $30,000
Decision:
NPV of buying new machine = Incremental Subsequent Annual Cash Inflow*PVIFA(8%,5) + Incremental Salvage Value*PVIF(8%,5) - Incremental Initial Investment = 8600*3.9927 + 30000*0.6806 - 76500 = -$21,744.78
Since the NPV of buying new machine is negative, we should not buy the new machine.
Tax Impact Capital Investment Projects typically have 4 major categories: 1. Initial Investment: Cash outflow to...
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