Question

13.

Artistic Adobes is considering growing its business by adding a paint machine that costs

$100,000. The machine will generate an additional $33,800 in before-tax operating

income (excluding depreciation) for the next five years. At the end of five years, the

machine can be sold for $9,500. The machine falls into the MACRS 3-year class (pg. 184

or 205). Artistic’s marginal tax rate is 39%, and its required rate of return is 13%. Should

Artistic purchase the machine?

Answer 1

Artistic can purchase the machine as NPV is postive after taking in to account 13% cost of capital. Working is detailed below:

Calculation of Depreciation-Machinery
	Year
	1	2	3	4	5
Investment	100000	67000	22000	7000
Depreciation Rate	33%	45%	15%	7%
Depreciation	33000	45000	15000	7000
Value at Year End	67000	22000	7000	0
CASH FLOW CALCULATION OF THE PROJECT
	Year
	1	2	3	4	5
Operating Income before Tax (Excluding Depreciation)-A	33800	33800	33800	33800	33800
Depreciation-B	33000	45000	15000	7000	0
Sale of machinery-C					9500
Net Income Before Tax and After depreciation -D =(A-B+C)	800	-11200	18800	26800	43300
Tax @39%-E	312	-4368	7332	10452	16887
Post Tax Operaing Income-F= (D*E)	488	-6832	11468	16348	26413
Add: Depreciation	33000	45000	15000	7000	0
Cash Flow from Income Side -G=(F+B)	33488	38168	26468	23348	26413
Calculation of NPV					Calculation of NPV		Calculation of IRR
Cash Outflow	Machiney				100000	Machinery	(100,000)
					100000	0	(100,000)
Cash In Flow
Year	Cash Inflow (A)			Discounting Factor @13%-B	Discounted Cash Flow-C=(A*B)
1	33488			0.8850	29,635.40	1	33,488
2	38168			0.7831	29,891.14	2	38,168
3	26468			0.6931	18,343.65	3	26,468
4	23348			0.6133	14,319.77	4	23,348
5	26413			0.5428	14,335.92	5	26413
					106,525.88
NPV of the Project is					6,525.88	IRR	15.84%
As we can see there is positive NPV after taking in t acount the cost of 13%, Artistic Adobes can purchase the Machine