Question

a. A new operating system for an existing machine is expected to cost $570,000 and have a useful life of six years. The system yields an incremental after-tax income of $235,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $14,000. b. A machine costs $600,000, has a $34,400 salvage value, is expected to last eight years, and will generate an after-tax income of $78,000 per year after straight-line depreciation Assume the company requires a 12% rate of return on its investments. Compute the net present value of each potential investment. (PV of $1. FV of $1. PVA of $1, and FVA of S1) (Use appropriate factor(s) from the tables provided.) Complete this question by entering your answers in the tabs below. Required A Required B A new operating system for an existing machine is expected to cost $570,000 and have a useful life of six years. The system yields an incremental after-tax income of $235,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $14,000. (Round your answers to the nearest whole dollar.) Select Chart Amount * PV Factor - Present Value Cash Flow Annual cash flow Residual value Net present value Required A Required 8 >

Answer 1

(a)

Calculate the net present value as follows:

Cash Flow	Select Chart	Amount	×	PV Factor	=	Present value
Annual cash flow	PVA of $1	327667	×	4.1114	=	1347170
Residual value	PV of $1	14000	×	0.5066	=	7092
	Present value of cash flows					1354263
	Less: Initial investment					570000
	Net present value					784263

Annual cash flow shown in the above chart has been calculated in the following manner:

Cost of operating system	570000
Less: Salvage value	14000
Depreciable amount	556000
Divide by: Useful life	6
Annual straight-line depreciation	92667
Add: After-tax income	235000
Annual cash flow	327667

(b)

Calculate the net present value as follows:

Cash Flow	Select Chart	Amount	×	PV Factor	=	Present value
Annual cash flow	PVA of $1	148700	×	4.9676	=	738682
Residual value	PV of $1	34400	×	0.4039	=	13894
	Present value of cash flows					752576
	Less: Initial investment					600000
	Net present value					152576

Annual cash flow shown in the above chart has been calculated in the following manner:

Cost of machine	600000
Less: Salvage value	34400
Depreciable amount	565600
Divide by: Useful life	8
Annual straight-line depreciation	70700
Add: After-tax income	78000
Annual cash flow	148700