Tocserp is considering the purchase of a new machine that will produce widgets.
ID: 2651000 • Letter: T
Question
Tocserp is considering the purchase of a new machine that will produce widgets. The widget maker will require an initial investment of $8,000 and has an economic life of five years and will be fully depreciated by the straight line method. The machine will produce 1,600 widgets per year with each costing $2.00 to make. Each will be sold at $4.50. Assume Tocserp uses a discount rate of 14 percent and has a tax rate of 34 percent. What is the NPV of the project and should Tocserp make the purchase.
Explanation / Answer
Calculation of depreciation
Depreciation =( Original cost - Scrap value )/ Useful life
Depreciation = 8000-0/5 i.e 1600
Contribution earned per unit = Sales price - Variable cost
= 4.50-2 i.e 2.50
Total contribution earned = 1600*2.50 i.e 4000
Net present value = Present value of cash inflows - Present value of cash outflows
= (Total contribution earned net of tax+Tax saving on depreciation) *PVAF(14%,5 years ) - Initial Investment
=(4000(0.66)+1600(0.34))*3.433-8000
= (2640+544)*3.433-8000
= 2930.67
Tocserp should make the project as the NPV of the project is positive
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