Question

1. A operating system for an existing machine is expected to cost $530,000 and have a useful life of six years. The system yields an incremental after-tax income of $175,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $20,800.
2. A machine costs $570,000, has a $20,600 salvage value, is expected to last eight years, and will generate an after-tax income of $66,000 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 $1)

Answer 1

Calculation of NPV of Machine A
Period	Initial Cash outflow	Net Cash Flow	Salvage	P.V.F @ 12%	N.P.V @ 12%
0	-530000			1.00000	-530,000
1-6		259,867		4.11141	1,068,418
6			20,800	0.50663	10,538
				Total	548,956
Calculation of NPV of Machine B
Period	Initial Cash outflow	Net Cash Flow	Salvage	P.V.F @ 12%	N.P.V @ 12%
0	-570000			1.00000	-570,000
1-8		134,675		4.96764	669,017
8			20,600	0.40388	8,320
				Total	107,337

Working Note:

	Machine A	Machine B
After Tax Income	175000	66000
Add: Dep.	84867	68675
Net Cash Flow	259867	134675
Cost	530000	570000
Life in Years	6	8
Salvage Value	20800	20600
Depreciable Value	509200	549400
Dep. As per SLM	84867	68675