Global tech, incorporated is considering the purchase of equipment with a cost o

Question

Global tech, incorporated is considering the purchase of equipment with a cost of $700,000, a salvage value of $100,000, an an estimated useful life of 5 years. Global tech depereciates all equipment using the double-declining balance method. Additionally, it expects to be subject to a tax rate of 25% in all 5 years.

Global tech projects cash flows directly resulting from the purchase of new equipment:

year 1: $285,000

year 2: $350,000

year 3. $290,000

year 4: $275,000

year 5: $255,000

Global tech uses a time value of money rate of 9% for decesion-making purposes. Assume the equipment is sold for the salvage value of $100,000 at the end of year 5 (no taxable gain or loss from the disposal is reported)

A. Calculate the payback period of the investment in the equipment.

b. Calculate the net present value of the investment in the equipment.

C. Calculate the profibililty index of the investment in the equipment.

Explanation / Answer

Equipment Cost $ 700000.00 Salvage value $ 100000.00 tax rate 25% Life 5 year Calculation of Depreciation Book value year start Dep. 40% on BV Book value year end 1 $ 700000.00 $ 280000.00 $ 420000.00 2 $ 420000.00 $ 168000.00 $ 252000.00 3 $ 252000.00 $ 100800.00 $ 151200.00 4 $ 151200.00 $ 51200.00 $ 100000.00 5 $ 100000.00 $ 0.00 $ 100000.00 Salvage value Calculation of NPV Cash flow Cash flow after tax Dep.tax saving Net CF DF 9% DCF 0 $ -700000.00 $ -700000.00 $ 0.00 -700000 1 $ -700000.00 1 $ 285000.00 $ 213750.00 $ 70000.00 283750 0.917431 $ 260321.10 2 $ 350000.00 $ 262500.00 $ 42000.00 304500 0.84168 $ 256291.56 3 $ 290000.00 $ 217500.00 $ 25200.00 242700 0.772183 $ 187408.93 4 $ 275000.00 $ 206250.00 $ 12800.00 219050 0.708425 $ 155180.54 5 $ 355000.00 $ 266250.00 0 266250 0.649931 $ 173044.23 NPV $ 332246.36 at 5 year cash flow (including salvage value $ 100000) Calculation of payback period Net CF Cummu.CF 1 $ 283750.00 $ 283750.00 2 $ 304500.00 $ 588250.00 3 $ 242700.00 $ 830950.00 4 $ 219050.00 $ 1050000.00 5 $ 266250.00 $ 1316250.00 payback period = 2 + $ 111750/$ 242700 = 2.46 year Profitability index = PV of future cash flow/intial investment Profitability index = $1032246/$700000 Profitability index = 1.47

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