Connor’s Cuisine restaurant is considering buying a new dishwashing machine. The
ID: 2594503 • Letter: C
Question
Connor’s Cuisine restaurant is considering buying a new dishwashing machine. The machine would cost $60,000 today. When sold as scrap at the end of three years, the machine should generate $3,000 as scrap. Connor’s could continue hiring college students on a part time basis to wash dishes at an annual payroll cost of $22,000. The dishwasher would increase outflows for power and water, manual washing leads to great breakage. Considering all these costs, the dishwasher would save $2,000 in operating costs, If Connor’s purchases the machine, it would use the straight-line depreciation method.
Use the net present value method to determine whether Connor’s should purchase the dishwasher.
4-1. Connor, the owner, claims he puts all his money in his mattress and never goes near banks. So Connor’s opportunity cost of capital is a less lumpy mattress. Ignore taxes for now.
4-2. Connor meets an investment banker, Ms. Portwood, and now realizes there is more to consider. He now estimates his cost of capital is 10%. Ignore taxes here, too.
4-3. Connor meets a tax advisor, Ms. Caire and realizes that taxes ought to be considered as well. The tax rate on his business return is 40%.
Explanation / Answer
Answer:
Given,
Intitial cost
$ 60,000.00
Life of Project
3years
Annual cash inflow
20000
salvage value
$ 3,000.00
Required Rate of return
10%
Net operating cost
Annual Outflow(payroll cost)
$ 2,000.00
Inflow-savings
$ 2,000.00
$20,000.00
If tax is not considered
Item
Years
Amount of cash flow
10% of factor
Present value of cash flow
Annual cash inflow
1-3years
$ 20,000.00
2.487
$ 49,740.00
Scrap
3rd year
$ 3,000.00
0.751
$ 2,253.94
$ 51,993.94
Initial Investment
$ 60,000.00
Net present value
$ (8,006.06)
If tax rate is considered
6.00%
Item
Years
Amount of cash flow
[10%*(1-40%)=6%] of factor
Present value of cash flow
Annual cash inflow
1-3years
$ 20,000.00
2.673
$ 53,460.00
Scrap
3rd year
$ 3,000.00
0.840
$ 2,518.86
$ 55,978.86
Initial Investment
$ 60,000.00
Net present value
$ (4,021.14)
Based on the above calculations of NPV ,in both the cases NPV is negative.
Purchasing Cost of Machine will not give much more benefit when compared with existing method of using Dishwasher by hiring parttime students.
Calculation of NPVGiven,
Intitial cost
$ 60,000.00
Life of Project
3years
Annual cash inflow
20000
salvage value
$ 3,000.00
Required Rate of return
10%
Net operating cost
Annual Outflow(payroll cost)
$ 2,000.00
Inflow-savings
$ 2,000.00
$20,000.00
If tax is not considered
Item
Years
Amount of cash flow
10% of factor
Present value of cash flow
Annual cash inflow
1-3years
$ 20,000.00
2.487
$ 49,740.00
Scrap
3rd year
$ 3,000.00
0.751
$ 2,253.94
$ 51,993.94
Initial Investment
$ 60,000.00
Net present value
$ (8,006.06)
If tax rate is considered
6.00%
Item
Years
Amount of cash flow
[10%*(1-40%)=6%] of factor
Present value of cash flow
Annual cash inflow
1-3years
$ 20,000.00
2.673
$ 53,460.00
Scrap
3rd year
$ 3,000.00
0.840
$ 2,518.86
$ 55,978.86
Initial Investment
$ 60,000.00
Net present value
$ (4,021.14)
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