Question

3. A company is considering the purchase of a new piece of testing equipment which is expected to produce $8,000 additional before-tax profit during the first year of operation; this amount will probably decrease by $500 per year for each additional year of ownership. The equipment costs $20,000 and will have estimated salvage value of $3,000 after 8 years of use. For a before-tax interest rate of 25%, determine the net present worth of this investment.

Answer 1

Computation of NPV of Investment-without considering Depreciation Years Particulars 0 1 2 3 4 5 6 8 Cash Outflows: Cost of Equipment (20,000) Cash Inflows Additional profit Salvage Value 8,000 7,500 7,000 6,500 6,000 5,500 5,000 4,500 3,000 Net Cash flows A= (20,000) PV factor @ 25% B= Present Value (AXB) = (20,000) 1.000 8,000 0.80000 6,400 7,500 0.64000 4,800 7,000 0.51200 3,584 6,500 0.40960 2,662 6,000 0.32768 1,966 5,500 0.26214 1,442 5,000 0.20972 1,049 7,500 0.16777 1,258 Net Present Worth of the Investment 3,161 2,125 per year If depreciation is to b considered, Annual Depreciation (Straight Line) = ($20000 - $ 3000) / 8 = $ This Depreciation Amount of $ 2,125 will be added in the Annual profits as it is a non cash Expenditure Computation of NPV of Investment (including Depreciation adjustment) Particulars 0 1 Cash Outflows: Cost of Equipment (20,000) Years 4 2 3 5 6 8 Cash Inflows Additional Cash inflows Salvage Value 10,125 9,625 9,125 8,625 8,125 7,625 7,125 6,625 3,000 Net Cash flows A= PV factor @ 25% B= Present Value (AXB) (20,000) 1.000 (20,000) 10,125 0.80000 8,100 9,625 0.64000 6,160 9,125 0.51200 4,672 8,625 0.40960 3,533 8,125 0.32768 2,662 7,625 0.26214 1,999 7,125 0.20972 1,494 9,625 0.16777 1,61 Net Present Worth of the Investment 10,235

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