Question
ABC Industries, Inc., needs a new lathe. It can buy a new high-speed lathe for $0.95...
| ABC Industries, Inc., needs a new lathe. It can buy a new high-speed lathe for $0.95 million. The lathe will cost $33,100 to run, will save the firm $131,300 in labour costs, and will be useful for 11 years. Suppose that for tax purposes, the lathe will be in an asset class with a CCA rate of 25%. ABC has many other assets in this asset class. The lathe is expected to have a 11-year life with a salvage value of $118,000. The actual market value of the lathe at that time will also be $118,000. The discount rate is 13% and the corporate tax rate is 35%. |
| What is the NPV of buying the new lathe? (Round your answer to the nearest cent.) | |
| NPV $ ______ | |
Answers
Please comment if the solution is correct
The NPV (Net Present Value) is simply the difference of Aggregate of Present value of all cash inflows and aggregate of present value of all cash outflows.
There are three types of cash flow associated with the purchase of the lathe machine:
1. Initial Investment (Purchasing cost plus cost to run machine)
2. Annual Savings ( After 25% percent depreciation tax will be deducted and then depreciation will be added back and then total of the present value is calculated)
3. Terminal Cash Inflow: (Inflow from selling the scrap after 11 years i.e. termination of the project and then getting the present value of the amount to be received at the end of 11th year)
Here, 1 is cash outflow whereas 2 and 3 are cash inflows.
Year 1 2 3 4 5 6 7 8 9 10 11 Annual Savings 131300 131300 131300 131300 131300 131300 131300 131300 131300 131300 131300 Less Running Cost 33100 33100 33100 33100 33100 33100 33100 33100 33100 33100 33100 Net Income 98200 98200 98200 98200 98200 98200 98200 98200 98200 98200 98200 Less CCA Deduction @ 25% 237500 178125 133593.8 100195.3 75146.48 56359.86 42269.9 31702.42 23776.82 17832.61 13374.46 Income before tax -139300 -79925 -35393.8 -1995.31 23053.52 41840.14 55930.1 66497.58 74423.18 80367.39 84825.54 Less Tax @ 35% -48755 -27973.8 -12387.8 -698.359 8068.73 14644.05 19575.54 23274.15 26048.11 28128.59 29688.94 Income after tax -90545 -51951.3 -23005.9 -1296.95 14984.79 27196.09 36354.57 43223.42 48375.07 52238.8 55136.6 Add Depreciation 237500 178125 133593.8 100195.3 75146.48 56359.86 42269.9 31702.42 23776.82 17832.61 13374.46 Net Annual Cash Flow 146955 126173.8 110587.8 98898.36 90131.27 83555.95 78624.46 74925.85 72151.89 70071.41 68511.06 PV factor @ 13% 0.884956 0.783147 0.69305 0.613319 0.54276 0.480319 0.425061 0.37616 0.332885 0.294588 0.260698 Present Value 130048.7 98812.55 76642.9 60656.22 48919.64 40133.47 33420.17 28184.1 24018.27 20642.22 17860.67 Add PV of terminal Cash Inflow 30762.32 Aggregate of present value of cash inflow 610101.2 Initial Investment 950000 NPV -339899 From the solution we can see that the NPV of the project is negative therefore the project is not profitable and not recommended for investment.
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