The COO of AppleLike Inc. is considering an investment in a new machine for iPad

Question

The COO of AppleLike Inc. is considering an investment in a new machine for iPadLike production. The machine costs $420,000. The COO expects to make iPadLikes on this machine for 6 years, and then he will no longer use the machine. Revenues are expected to be $100,000 each year for this machine. The machine is also expected to decrease production costs of the company by $35,000 per year. There is no net change in working capital due to the new machine. The market value of the machine in 6 years is expected to be $15,000. The company will depreciate the machine using straight-line depreciation, the corporate tax rate is 20%, and the required rate of return demanded by the company on any capital expenditure is 18%. Should the company buy the machine? Provide the NPV to justify your choice.

Explanation / Answer

Since NPV of the project is positive, the company should buy the machine

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Increase in revenue (A)       100,000       100,000       100,000       100,000       100,000       100,000 Decrease in costs (B)          35,000          35,000          35,000          35,000          35,000          35,000 Net Increase (C=A+B)       135,000       135,000       135,000       135,000       135,000       135,000 Tax on Net Increase @ 20% (D)          27,000          27,000          27,000          27,000          27,000          27,000 After Tax Net Increase (E=C-D)       108,000       108,000       108,000       108,000       108,000       108,000 Tax savings on Depreciation ((420000-15000)/6)*20% (F)          13,500          13,500          13,500          13,500          13,500          13,500 After Tax Salvage Value (15000*(1-0.2)) (G)          12,000 Purchase of machine (H) -       420,000 Net Cashflows (I=E+F+G+H) -       420,000       121,500       121,500       121,500       121,500       121,500       133,500 Discounting factor @ 18% (J) 1              0.85              0.72              0.61              0.52              0.44              0.37 (1/1.18) (0.85/1.18) (0.72/1.18) (0.61/1.18) (0.52/1.18) (0.44/1.18) Present Value of cashflows (K=I*J) -       420,000       102,966          87,259          73,949          62,668          53,109          49,453 NPV (Sum of K)              9,404

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