VT is considering investing in a new piece of equipment that cost $100.000.00. I

Question

VT is considering investing in a new piece of equipment that cost $100.000.00. If the copany buys the equipment their inventory will increase $10,000.00. The new equipment will have a useful life of 5 years and will depreciate in straight line depreciation. At the of 5 years the equipment will sell for $15,000.00. The investment will help generate additional revenue of $250,000.00 per year with a cost of $220,000.00 before depreciation. The company is in a 40% tax bracket. The cost for capital is 10%.

1.) What is the initial  cash flow if the company purchases the equipment?

2.) What is the after tax cash flow from the sale of the equipment?

3.) What is the annaul cash flow?

4.) What is the net present value?

5.) Should Vt buy the equipment? And Why?

Explanation / Answer

1]INITIAL CASHFLOW IF THE COMPANY PURCHASES THE EQUIPMENT = PURCHASE COST + INCREASE IN WORKING CAPITAL

=100000+10000

=110000

2]AFTER TAX CASHFLOW FROM THE SALE OF EQUIPMENT = 15000

3]ANNUAL CASHFLOW = [ADDITIONAL REVENUE-ADDITIONAL EXPENSE-DEPRECIATION](1-T) + DEPRECIATION

=[250000-220000-(100000-15000)/5]*0.6 + (100000-15000)/5

=24800

NOTE:-IN 5TH YEAR CASHFLOW OF $ 10000 WOULD BE IN ADDITION TO THE ANNUAL CASHFLOW OF 24800.[RECOVERY OF WORKING CAPITAL]

4]NPV = 24800*PVIFA(10%,5) + 10000*PVIF(10%,5)

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