A manufacturer wants to introduce new factory equipment that requires machinery

Question

A manufacturer wants to introduce new factory equipment that requires machinery to be purchased today for $120 million. This new machine will last for five years, and will be depreciated straight-line to a value of zero at the end of year five. The extra savings from the new machine are expected to produce project inflows of $47 million per year, beginning one year from today, for five consecutive years. The machine does carry extra costs such that project outflows will be $9 million per year, beginning one year from today, for five consecutive years. If the firm’s tax rate is 30% and the required rate of return is 11%, which of the following comes closest to the NPV of the new equipment project?

($1.12) million

$1.84 million

$8.13 million

$4.92 million

($3.96) million

a.

($1.12) million

b.

$1.84 million

c.

$8.13 million

d.

$4.92 million

e.

($3.96) million

Explanation / Answer

Depreciation = Investment / 5

Cash Flows = Profits + Depreciation

NPV = NPV(11%, 33.8...33.8) - 120 = 4.92

Hence, d is correct

0 1 2 3 4 5 Investment -120 Savings 47 47 47 47 47 Cost -9 -9 -9 -9 -9 Depreciation -24 -24 -24 -24 -24 EBT 14 14 14 14 14 Tax (30%) -4.2 -4.2 -4.2 -4.2 -4.2 Profits 9.8 9.8 9.8 9.8 9.8 Cash Flows -120 33.8 33.8 33.8 33.8 33.8 NPV $4.92

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