A Company purchased a new machine with a service life of seven years and no resi

Question

A Company purchased a new machine with a service life of seven years and no residual value on January 1, 20X6, for $400,000. The machine was depreciated using the straight-line method and it was expected to produce annual cash flow from operations, net of income taxes, of $90,000. The present value for an ordinary annuity of $1 for seven periods at 12% is 4.564. The present value of $1 for seven period at 12% is 0.452. Assuming that the company used a rate of return of 12%, what was the net present value on the date of purchase?

Explanation / Answer

Net Present Value on the date of purchase:

Annual cashflow from operations, net of incometaes for 7 years = 90,000

Annuity Present value factor @12% for 7 years = 4.564

Therefore present value of annual cashflows = 90,000 x 4.564 = $ 410,760.

Salvage value = 0.

Cost of purchase = $ 400,000.

Net Present Value on the date of purchase = 410,760 -400,000 = $ 10,760.

Assumption: As annual cash flow from operations, net of income taxes is given, it is assumed that tax shield on depreciation is also included in it.

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