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Natchez, Inc. is considering the purchase of a new machine costing $200,000. The company will incur $5,000 per year in cash operating expenses but it will allow the company to earn an additional $100,000 per year in revenues. Natchez expects the machine to provide future benefits for 3 years and salvage value at the end of the 3-year period to be $10,000. The company uses straight-line depreciation method. The income tax rate is 30%. If the required rate of return is 10%, how much is the net present value of this project? Select one: a. $12, 629 b. None of these answers are correct. c. $43, 769 d. $20, 143
Expert Answer
Answer is b.
Cost of Machine = $200,000
Salvage Value = $10,000
Useful Life of Machine = 3 years
Annual Additional Income = $100,000
Annual Operating Expenses = $5,000
tax rate = 30%
Annual Depreciation = (Cost of Machine + Salvage Value) / Useful Life
Annual Depreciation = ($200,000 + $10,000) / 3
Annual Depreciation = $70,000
Annual OCF = (Annual Income – Annual Expenses)*(1-tax) + tax*Annual Depreciation
Annual OCF = ($100,000 – $5,000)*(1-0.30) + 0.30*$70,000
Annual OCF = $87,500
Net Present Value = -$200,000 + $87,500*PVIFA(10%, 3) + $10,000*PVIF(10%, 3)
Net Present Value = -$200,000 + $87,500*(1-(1/1.10)^3)/0.10 + $10,000/1.10^3
Net Present Value = $25,112.70
