Question

A manufacturer wants to introduce new factory equipment that requires machinery to be purchased today for $120 million. This new machine will last for five years, and will be depreciated straight-line to a value of zero at the end of year five. The extra savings from the new machine are expected to produce project inflows of $47 million per year, beginning one year from today, for five consecutive years. The machine does carry extra costs such that project outflows will be $9 million per year, beginning one year from today, for five consecutive years. If the firm's tax rate is 30% and the required rate of return is 13%, which of the following comes closest to the NPV of the new equipment project? a. ($3.96) million b. $1.84 million c. $4.92 million d. $8.13 million e. ($1.12) million

Answer 1

e. ($1.12) million

Working:

# 1	Depreciation expense			=	(Cost - Salvage Value)/Useful Life
				=	(120-0)/5
				=	$           24
# 2	Calculation of NPV:	(Amounts are in million)
	Year (a)	0	1	2	3	4	5		Total
	Machinery cost	$ -120.00
	Cash inflows		$     47.00	$     47.00	$     47.00	$     47.00	$     47.00
	Cash outflows		$     -9.00	$     -9.00	$     -9.00	$     -9.00	$     -9.00
	Depreciation Expense		$   -24.00	$   -24.00	$   -24.00	$   -24.00	$   -24.00
	Profit Before tax (s)		$     14.00	$     14.00	$     14.00	$     14.00	$     14.00
	Tax Expense (t=s*-30%)		$     -4.20	$     -4.20	$     -4.20	$     -4.20	$     -4.20
	Net Income		$       9.80	$       9.80	$       9.80	$       9.80	$       9.80
	Depreciation Expense		$     24.00	$     24.00	$     24.00	$     24.00	$     24.00
	Cash flows (x)	$ -120.00	$     33.80	$     33.80	$     33.80	$     33.80	$     33.80
	Discount factor (b=1.13^-a)	1.0000	0.8850	0.7831	0.6931	0.6133	0.5428
	Present Value (c=x*b)	$ -120.00	$     29.91	$     26.47	$     23.43	$     20.73	$     18.35		$     -1.12
Thus,
	Project's NPV is	$      -1.12	Million