Question

Bayleaf Inc is considering the purchase of a machine that costs $250,000. The machine is expected to generate revenues of $85,000 per year for five years. The machine would be depreciated using the straight-line method over a five-year life and have no salvage value. The company considers the impact of income taxes in all of its capital investment decisions. The company has a 40 percent income tax rate and desires an after-tax rate of return of 12 percent on its investment

Compute the net present value of the machine.

*Minimum of 400 words* Please explain answer

Answer 1

Annual Operating Cash Flow (OCF)

Annual Operating Cash Flow (OCF) = [Revenues x (1 – Tax rate)] + [Depreciation x Tax Rate]

= [$85,000 x (1 – 0.40)] + [($250,000 / 5 Years) x 0.40]

= [$85,000 x 0.60] + [$50,000 x 0.40]

= $51,000 + $20,000

= $71,000 per year

Initial Investment Cost

Initial Investment Cost = $250,000

The Net Present Value (NPV) of the machine

Year	Annual cash flows ($)	Present Value Factor (PVF) at 12.00%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	71,000	0.8928571	63,392.86
2	71,000	0.7971939	56,600.77
3	71,000	0.7117802	50,536.40
4	71,000	0.6355181	45,121.78
5	71,000	0.5674269	40,287.31
TOTAL		2,55,939.11

The Net Present Value (NPV) of the Machine = Present value of annual cash inflows – Initial investment costs

= $2,55,939.11 - $250,000

= $5,939.11

“Hence, the Net Present Value (NPV) of the machine will be $5,939.11”

NOTE

The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)n], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.