Johnny’s Lunches is considering purchasing a new, energy-efficient grill. The gr

Question

Johnny’s Lunches is considering purchasing a new, energy-efficient grill. The grill will cost $36,000 and will be depreciated according to the 3-year MACRS schedule. It will be sold for scrap metal after 3 years for $9,000. The grill will have no effect on revenues but will save Johnny’s $18,000 in energy expenses. The tax rate is 30%. Use the MACRS depreciation schedule.

a. What are the operating cash flows in each year? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Year Operating Cash Flows

1 $

2

3

b. What are the total cash flows in each year? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places.)

Time Total Cash Flows

0 $

1

2

3

c. If the discount rate is 10%, should the grill be purchased?

Yes No

Explanation / Answer

Part A)

The operating cash flows have been calculated with the use following table:

_______

Part B)

The total cash flows have been calculated with the use of following table:

_______

Part C)

To determine whether the project should be accepted or not, we need to calculate the NPV. The formula for NPV is given below:

NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Discount Rate)^1 + Cash Flow Year 3/(1+Discount Rate)^2 + Cash Flow Year 3/(1+Discount Rate)^3

_______

Using the values calculated in Part B in the above formula, we get,

NPV = -36,000 + 16,199.94/(1+10%)^1 + 17,400.60/(1+10%)^2 + 21,299.76/(1+10%)^3 = $9,110.70

Since, the NPV is positive, the grill should be purchased.

Answer is Yes.

Year 1 Year 2 Year 3 Savings before Tax and Depreciation 18,000 18,000 18,000 Less Depreciation 11,998.80 (36,000*33.33%) 16,002 (36,000*44.45%) 5,331.60 (36,000*14.81%) Savings after Depreciation before tax 6,001.20 1,998.00 12,668.40 Less Tax 1,800.36 599.4 3,800.52 Savings after Tax 4,200.84 1,398.60 8,867.88 Add Depreciation 11,998.80 16,002 5,331.60 Operating Cash Flow $16,199.64 $17,400.60 $14,199.48

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