If a machine costs $2.5 million and is expected to last for 5 years with no salv

Question

If a machine costs $2.5 million and is expected to last for 5 years with no salvage value. Straight line depreciation will be used. Cash inflows, currently at $5 million per year, are expected to increase to $5,750,000 annually if the machine is purchased. Assume that the machinery can begin to increase cash flow in 1 year, and the company expenses are consistently 60% of cash flows, what is the after tax cash flow in each year of the next 5 years? Tax rate is 34%. If the discount rate is 10%, do we accept this project based on NPV rule?

Explanation / Answer

Hi,

Please find the detailed answer as follows:

After Tax Cash Flow (for each of 5 Years) = (5750000 - 60%*5750000 - 2500000/5)*(1-34%) + 2500000/5 = $1688000

NPV = -2500000 + 1688000/(1+10%)^1 + 1688000/(1+10%)^2 + 1688000/(1+10%)^3 + 1688000/(1+10%)^4 + 1688000/(1+10%)^5 = $3898848.07

Yes, the machine should be purchased as it results in a +NPV.

Thanks.

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