Question

Fairfax Pizza is considering buying a new oven. The new oven would be purchased today for 19,000 dollars. It would be depreciated straight-line to 2,000 dollars over 2 years. In 2 years, the oven would be sold for an after-tax cash flow of 3,300 dollars. Without the new oven, costs are expected to be 11,500 dollars in 1 year and 17,900 in 2 years. With the new oven, costs are expected to be -500 dollars in 1 year and 11,600 in 2 years. If the tax rate is 50 percent and the cost of capital is 9.25 percent, what is the net present value of the new oven project?

Answer 1

Initial Investment	Amount in $
New Oven Purchase - Outflow	-19000

	Annual Cash Flows ( in $)	Year
		1	2
A	Saving in cost by new oven	11500	17900
B	Increase in cost by new oven	-500	-11600
C	NET Annual Cashflow before Depreciation and Taxes	11000	6300
D	Depreciation	-8500	-8500
E	NET Annual Cashflow after deprecation but before tax	2500	-2200
F	Tax ( 50%) - E*50%	1250	-1100
G	Depreciation - Added Back	8500	8500
	Annual Cashflow after Taxes	9750	7400

* Note - Depreciation is not available for Old oven so it is assumed to be NIL

Terminal Cash flow	Amount in $
Scrap Value	3300

Year	Net Cashflow (A)	Formula for PV Factor ( 1+r)^n	PV Factor @9.25%	Amount in $
0	-19000	1	1	-19000
1	9750	1/1.0925	0.9153	8924.485
2	7400	1/1.0925^2	0.8378	6199.959
2	3300	1/1.0925^2	0.8378	2764.847
NET PRESENT VALUE				-1110.71

NPV is Negative that means New oven Purchase is not advisable.