Co. is considering purchasing a piece of equipment costing $300,000. It has a us

Question

Co. is considering purchasing a piece of equipment costing $300,000. It has a useful life of 3 years and will be depreciated straight-line to zero, after which it will be scrapped for $20,000. This piece of equipment will save Teer Co. $125,000 per year in pretax operating costs during its useful life but requires an initial investment in NWC of $50,000. Teer Co. has a 20% tax rate and a required rate of return of 10%.

What is the annual Operating Cash Flow (OCF) of this piece of equipment in Years 1-3?

A.) 170k

B.) 149k

C.) 98k

D.) 120k

What is the Year 3 IATCF (Investment After-Tax Cash Flow)? Hint: You need to account for the after-tax salvage value and for net working capital.

A.) 142k

B.) 186k

C.) 171k

D.) 204k

What is the NPV of purchasing this piece of equipment?

A.)-$1991

B.)$2874

C.)$4096

D.) -$3984

Explanation / Answer

Solution: Calculation of NPV Particulars Years Amount PVF @ 10% Present Value Cash Outflows: Purchase Amount 0    300,000 1        300,000.00 Net Working Capital 0      50,000 1           50,000.00 Present Value of Cash Outflows(A)    350,000        350,000.00 Cash Inflows: Operating Cost Flow after Tax (125000-(1-0.20)) 1-3    100,000 2.4869        248,690.00 Tax Saving on Depreciation (300000/3)*20% 1-3      20,000 2.4869           49,738.00 Scrapped Value (Net of Tax) ( 20000)(1-0.20) 3      16,000 0.7512           12,019.20 Net Working Capital 3      50,000 0.7512           37,560.00 Present Value of Cash Inflows (B)    186,000 348,007.20 NPV (B)-(A) (1992.80) (approx) 1. Option D is correct i.e. 120K Operating cash flow after tax + tax saving on depreciation = 100000+20000= 1,20,000 2. Option B is correct i.e. 186K Year 3 IATCF- Operating Cash Flow after Tax + Tax Saving on Depreciation + Scrapped Value + Net Working Capital Year 3 IATCF- 100000+20000+16000+50000= 1,86,000 3. Option A is correct i.e. - $1991 NPV -$1991 as shown in the above table

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