Question

a. A new operating system for an existing machine is expected to cost $520,000 and have a useful life of six years. The system yields an incremental after-tax income of $150,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $10,000. b. A machine costs $380,000, has a $20,000 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 10% 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.)

Answer 1

Answer:

NPV of Project A = $1,023,425 +$5,640 - $520,000 = $509,065

NPV of Project B= $560,175 + $9,320 - $380,000 = $189,495

Explanation:

Net Present Value = Present value of cash inflows - Present value of cash outflow

For project A

Annual cash inflow = After tax income + Depreciation

= $150,000 + ($520,000 - $10,000)/6 = $150,000 + $85,000 = $235,000

Present value of out flow = $520,000

Present value of inflows = PVAF 10%, 6 years = 4.355 X $235,000 = $1,023,425

Present value of Salvage = PVIF 10%, 6th year = 0.564 X $10,000 = $5,640

NPV of Project A = $1,023,425 +$5,640 - $520,000 = $509,065

For project B

Annual cash inflow = After tax income + Depreciation

= $60,000 + ($380,000 - $20,000)/8 = $60,000 + $45,000 = $105,000

Present value of out flow = $380,000

Present value of inflows = PVAF 10%, 8 years = 5.335 X $105,000 =$560,175

Present value of Salvage = PVIF 10%, 8 = 0.466 X $20,000 = $9,320

NPV of Project B= $560,175 + $9,320 - $380,000 = $189,495

NPV of Project A = $1,023,425 +$5,640 - $520,000 = $509,065

NPV of Project B= $560,175 + $9,320 - $380,000 = $189,495