Calculate the NPV of an investment with the following conditions and conclude wh
ID: 2743688 • Letter: C
Question
Calculate the NPV of an investment with the following conditions and conclude which is better. Purchase the asset: purchasing the asset requires capital cost of 400,000 dollars (At time zero) that can be depreciated based on MACRS 7 year life depreciation with the half year convention over eight years ( from year 0 to 7). And the salvage value will be 100,000 dollars at the end of year 7. Lease (operating lease): The asset can be leased for 7 years at annual operating lease payments (LP) of 70,000 dollars( from year 1 to year 7) The asset would yield the annual revenue of $150,000 and operating cost of $40,000 for seven years (year 1 to 7). Considering income tax of 40% and minimum ROR of 8%. Calculate ATCF and NPV for both options and conclude which is better.
Explanation / Answer
We assume straight line depreciation.
The rate of return is 0.08.
We proceed with the calculations in the tabular format below.
The ATCF and NPVs are as shown in the table.
So, it is better to lease the asset.
0 1 2 3 4 5 6 7 NPV Revenue (Inflow) 150 150 150 150 150 150 150 Cash Outflow for Operations 40 40 40 40 40 40 40 Discount Factor 1 0.902527 0.857339 0.793832 0.73503 0.680583 0.63016963 0.58349 Option 1 Cash Flow from the asset -400 100 After Tax Cash Flow from Operations 66 66 66 66 66 66 126 Depreciation 18.75 37.5 37.5 37.5 37.5 37.5 37.5 56.25 Tax Shields 7.5 15 15 15 15 15 15 22.5 Net Cash Flow (ATCF) -392.5 81 81 81 81 81 81 148.5 PV of Cash Flows -392.5 73.10469 69.44444 64.30041 59.53742 55.12724 51.0437398 86.64832 66.70627 Option 2 Cash Flow from the asset 70 70 70 70 70 70 70 Cash Flow from Operations 40 40 40 40 40 40 40 Net Cash Flow (ATCF) 24 24 24 24 24 24 24 PV of Cash Flows 0 21.66065 20.57613 19.05197 17.64072 16.334 15.124071 14.00377 124.3913Related Questions
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