Question

The board of directors, of XYZ, Inc., is evaluating a new piece of equipment that would decrease operating costs by $50,000. The project's cost is $70,000. The project has a 3-year depreciable life and the company will use accelerated depreciation. At the end of 3 years, the will be scrapped. In other words, the salvage value will be zero. The tax rate is 40% and the project’s cost of capital is 12%.

1). Determine the projects’ NPV (all work needs to be shown)

2). Would you purchase the equipment and why?

Answer 1

XYZ	0	1	2	3
MACRS %		33.33%	44.45%	14.81%
Investment	-70,000
Savings		50,000	50,000	50,000
Depreciation		-23,331	-31,115	-10,367
EBT		26,669	18,885	39,633
Tax (40%)		-10,668	-7,554	-15,853
Profits		16,001	11,331	23,780
Cash Flows	-70,000	39,332	42,446	34,147
NPV	$23,260.92

First, we need find the depreciation rates for 3-year lifes from MACRS table.

Depreciation = Investment x MACRS (%)

Cash Flows = Investment + Profits + Depreciation

NPV = - 70,000 + 39,332 / (1 + 12%) + 42,446 / (1 + 12%)^2 + 34,147 / (1 + 12%)^3

= $23,260.92

As the NPV > 0, you should purchase the equipment.