The Summitt Petroleum Corporation will purchase an asset that qualifies for thre

Question

The Summitt Petroleum Corporation will purchase an asset that qualifies for three-year MACRS depreciation. The cost is $260,000 and the asset will provide the following stream of earnings before depreciation and taxes for the next four years: Use Table 12-9.

rev:4_5_2013_QC_29129

Calculate the net present value. (Round "PV Factor" to 3 decimal places, intermediate calculations and final answer to the nearest whole dollar amount. Omit the "$" sign in your response.)

rev: 12_14_2012

Explanation / Answer

Answer a.

Cost of Asset = $260,000

Depreciation Year 1 = 33.33%*$260,000 = $86,658
Depreciation Year 2 = 44.45%*$260,000 = $115,570
Depreciation Year 3 = 14.81%*$260,000 = $38,506
Depreciation Year 4 = 7.41%*$260,000 = $19,266

Year 1:

Net Cash Flow = EBIT*(1-tax) + tax*Depreciation
Net Cash Flow = $130,000*(1-0.35) + 0.35*$86,658
Net Cash Flow = $114,830.30

Year 2:

Net Cash Flow = EBIT*(1-tax) + tax*Depreciation
Net Cash Flow = $173,000*(1-0.35) + 0.35*$115,570
Net Cash Flow = $152,899.50

Year 3:

Net Cash Flow = EBIT*(1-tax) + tax*Depreciation
Net Cash Flow = $62,000*(1-0.35) + 0.35*$38,506
Net Cash Flow = $53,777.10

Year 4:

Net Cash Flow = EBIT*(1-tax) + tax*Depreciation
Net Cash Flow = $60,000*(1-0.35) + 0.35*$19,266
Net Cash Flow = $45,743.10

NPV = -$260,000 + $114,830.30 * PV of $1 (16%, 1) + $153,899.50 * PV of $1 (16%, 2) + $53,777.10 * PV of $1 (16%, 3) + $45,743.10 * PV of $1 (16%, 4)
NPV = -$260,000 + $114,830.30 * 0.862 + $153,899.50 * 0.743 + $53,777.10 * 0.641 + $45,743.10 * 0.552
NPV = $13,052.36

Answer b.

Summit Petroleum Corporation should purchase this asset.

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