Consider a project that involves the purchase of a $10,000 machine that will red

Question

Consider a project that involves the purchase of a $10,000 machine that will reduce pretax operating costs by $3,000 per year over the next five years.  It will not require any changes in net working capital and is expected to have a salvage value of $1,000 in five years.  The machine will be depreciated according to the five-year MACRS schedule (note that this schedule has 6 years of depreciation, but the machine will be sold after 5 years).  The tax rate is 34%, and the discount rate is 10%.  Construct a table of the relevant cash flows, and compute the NPV and IRR.  Round all amounts to the nearest dollar.

1             20

2             32

3             19.20

4            11.52       

5            11.52

6             5.76

Show all work.  Thank you

Explanation / Answer

Year Cost Revenue MACRS% Depreciation Taxable Income Tax cash flow excluding salvage value 0 $10,000 0 0 ($10,000) 1 $0 $3,000 20.00 $2,000 $1,000 $340 $2,660 2 $0 $3,000 32.00 $3,200 ($200) ($68) $3,068 3 $0 $3,000 19.20 $1,920 $1,080 $367 $2,633 4 $0 $3,000 11.52 $940 $2,060 $700 $2,300 5 $0 $4,000 11.52 $940 $3,060 $1,040 $2,960 5.76 Salvage value = $1,000 Book Value $576 Profit on Salvage Value $424 Tax on Salvage value $144.00 Post Tax Salvage Value $856.00 Year Cash flow NPV 0 ($10,000) $ (10,000.00) 1 $2,660 $      2,418.00 2 $3,068 $      2,536.00 3 $2,633 $      1,978.00 4 $2,300 $      1,571.00 5 $3,816 $      2,369.00 NPV = $         872.00 IRR 13.25%

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