Johnny\'s Lunches is considering purchasing a new, energy efficient grill. The g

Question

Johnny's Lunches is considering purchasing a new, energy efficient grill. The grill will cost $20,000 and will be depreciated in an asset class that carries a CCA rate of 30%. It will be sold for scrap metal after 3 years for $5000. THe grill will have no effect on revenues but will save Johnny's $10000 in energy expenses. The firm has other assets in this asset class. The tax rate is 35%.

a) What are the operating cash flows in years 1 to 3?

b) What are total cash flows in years 1 to 3?

c) If the discount rate is 12%, should the grill be purchased?

Explanation / Answer

cost of the asset salvage value savings per year tax rate $20,000 5,000 10,000 35% year depreciation per year 1 6,000 2 4,200 3 2,940 year cash flows discount rate 12% present value of cash flows 1 2,600 0.893 2321.8 2 3,770 0.797 3004.69 3 4,589 0.712 3267.368 10,959 8593.858 present value = -20,000+ 8593.858 + 3560 = -7,900.14 The present value of the grill is negative hence should not be purchased.

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