A company is considering purchasing an asset for $60,000 that would have a usefu

Question

A company is considering purchasing an asset for $60,000 that would have a useful life of 5 years and would have a salvage value of $7,000. For tax purposes, the entire original cost of the asset would be depreciated over 5 years using the straight-line method and the salvage value would be ignored. THe asset would generate the annual net cash inflows of $27,000 throughout its useful life. The project would require additional working capital of $1,000, which would be released at the end of the project. The company's tax rate is 30% and its discount rate is 10%

Required:
What is the net present value of the asset?

Explanation / Answer

Net present value of the asset = present value of cash inflow - present value of cash outflow

= 88651.20 - 61000

= 27651.20

Present value of cash outflow = Purchase cost of asset * PVF (at year 0 ) + working capital * PVF (at year 0 )

= $60,000 * 1 + 1000 * 1 = 61000

Present value of cash inflow = Cash inflow * cummulative PVF (for n number of years ) + Salvage value (at y=5) + working capital release (at Year=5)

= 22080 * 3.79 + 7000 * .621 + 1000*.621 = 88651.20

Cash inflow =

Net cashflow (a)= 27000

Less - depreciation = 10600 [60000- 7000)/ 5]

Cash flow before tax = 16400

Less- tax @ 30% (b)= 4920

Cash flow after tax (a-b) = 22080

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