Question

photographic film. Stikine River Photo is considering purchase of improved equipment for their laboratory at Telegraph Creek. Here is the information they have:

• The equipment costs $100,000 and will cost $80,000 per year to run.
• It has an economic life of 10 years but can be depreciated over five years by the straight-line method.
• It will recover an additional 5,000 ounces of silver per year.
• Silver is selling for $40 per ounce. Over the past 10 years, the price of silver has appreciated by 4.5% per year in real terms. Silver is traded in an active, competitive market.
• Stikine's marginal tax rate is 25%.
• Stikine's company cost of capital is 8% in real terms.
• The nominal interest rate is 6%.

What is the NPV of the new equipment? Assume 2017 Tax Cuts and Jobs Act, where 100% write-off of investment expenditures, is not applicable. (Do not round intermediate calculations. Round your answer to nearest whole dollar amount.)

Answer 1

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10
Initial outlay	$100,000
Extra income(1)		$209,000	$218,405	$228,233.225	$238,503.7201	$249,236.3875	$260,452.025	$272,172.3661	$284,420.1226	$297,219.0281	$310,593.8843
Operating cost		$80,000	$80,000	$80,000	$80,000	$80,000	$80,000	$80,000	$80,000	$80,000	$80,000
Depreciation(2)		$20,000	$20,000	$20,000	$20,000	$20,000	0	0	0	0	0
Operating Income		$109,000	$118,405	$128,233.225	$138,503.7201	$149,236.3875	$260,452.025	$272,172.3661	$284,420.1226	$297,219.0281	$310,593.8843
Tax (25%)		27250	29601.25	32058.3063	34625.93	37309.0969	45113.0063	48043.0915	51105.0307	54304.757	57648.4711
Profit after Tax		81750	88803.75	96174.9188	103877.79	111927.291	135339.019	144129.275	153315.092	162914.271	172945.413
PV (using the cost of capital of 8%)	-100,000	75694.4	76134.9	76346.7513	76353.2767	76175.8333	85286.5389	84098.0474	82831.3737	81497.6958	80107.1892

NPV = $694,526.10

(1) Calculated as 5,000*($40*appreciation of 4.5% in the price of Silver)

(2) Depreciation of $100,000 in 5 years using straight-line method gives $20,000 per year for 5 years

Note 1: The values in the table have been calculated in Excel and copied from there

Note 2: The price appreciation of silver is given in real terms and hence the discount rate should also be in real terms of 8%