Question

1. A new operating system for an existing machine is expected to cost $760,000 and have a useful life of six years. The system yields an incremental after-tax income of $270,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $24,400.
2. A machine costs $460,000, has a $30,800 salvage value, is expected to last eight years, and will generate an after-tax income of $60,000 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) (Use appropriate factor(s) from the tables provided.)
Required A Required B A new operating system for an existing machine is expected to cost $760,000 and have a useful life of six years. The systei yields an incremental after-tax income of $270,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $24,400. (Round your answers to the nearest whole dollar.) Cash Flow Amount * PV Factor = Present Value Annual cash flow Residual value Select Chart Present Value of an Annuity of 1 Present Value of 1 Present value of cash inflows Present value of cash inflows Net present value Required A Required B >

Answer 1

Ans. A	*Depreciation = (Cost of project - Salvage value) / Useful life in years
	($760,000 - $24,400) / 6
	$735,600 / 6
	$122,600
	*Calculations for Net annual cash flow:
	Net income	$270,000
	Add: Depreciation	$122,600
	Net cash inflow	$392,600
	Cash Flow	Select Chart	Amount *	PV factor =	Present value
	Annual cash flow	Present value of an annuity of $1	$392,600	4.1114	$1,614,136
	Residual value	Present value factor of year 6	$24,400	0.5066	$12,361
		Present value of cash inflows			$1,626,497
		Initial cash outflows			-$760,000
		Net present value			$866,497
	Residual value is considered the cash inflow of the end of useful life.
	*Calculation of Present value factor @ 12%.
	Year		PV @ 12%
	1	1 / (1 + 0.12)^1	0.8929
	2	1 / (1 + 0.12)^2	0.7972
	3	1 / (1 + 0.12)^3	0.7118
	4	1 / (1 + 0.12)^4	0.6355
	5	1 / (1 + 0.12)^5	0.5674
	6	1 / (1 + 0.12)^6	0.5066
	Total of Present value of an annuity		4.1114
Ans. B	*Depreciation = (Cost of project - Salvage value) / Useful life in years
	($460,000 - $30,800) / 8
	$429,200 / 8
	$53,650
	*Calculations for Net annual cash flow:
	Net income	$60,000
	Add: Depreciation	$53,650
	Net cash inflow	$113,650
	Cash Flow	Select Chart	Amount *	PV factor =	Present value
	Annual cash flow	Present value of an annuity of $1	$113,650	4.9676	$564,568
	Residual value	Present value factor of year 8	$30,800	0.4039	$12,440
		Present value of cash inflows			$577,008
		Initial cash outflows			-$460,000
		Net present value			$117,008
	Residual value is considered the cash inflow of the end of useful life.
	*Calculation of Present value factor @ 12%.
	Year		PV @ 12%
	1	1 / (1 + 0.12)^1	0.8929
	2	1 / (1 + 0.12)^2	0.7972
	3	1 / (1 + 0.12)^3	0.7118
	4	1 / (1 + 0.12)^4	0.6355
	5	1 / (1 + 0.12)^5	0.5674
	6	1 / (1 + 0.12)^6	0.5066
	7	1 / (1 + 0.12)^7	0.4523
	8	1 / (1 + 0.12)^8	0.4039
	Total of Present value of an annuity		4.9676