Topsider Inc.is considering the purchase of a new leather-cutting machine to replace an existing machine that has a book value of $3,000 and can be sold for $1,500.The old machine is being depreciated on a straight-line basis, and its estimated salvage value 3 years from now is zero.The new machine will reduce costs (before taxes) by $7,000 per year.The new machine has a 3-year life, it costs $14,000, and it can be sold for an expected $2,000 at the end
Of the third year.The new machine would be depreciated over its 3-year life using the MACRS method.Assuming a 40 percent tax rate and a required rate of return of 16 percent, find the new machine's NPV.

Question

Quizplus · Accepted Answer

The correct answer is B because the NPV of the new machine is $1,658. The NPV is calculated as follows:Initial investment: -$14,000After-tax salvage value: $2,000 x (1 - 0.4) = $1,200Annual after-tax cost savings: $7,000 x (1 - 0.4) = $4,200Depreciation expense: $14,000 / 3 = $4,667Tax savings from depreciation: $4,667 x 0.4 = $1,867Annual after-tax cash flows: $4,200 + $1,867 = $6,067PV of after-tax cash flows: $6,067 x (1 - 1 / (1 + 0.16)^3) / 0.16 = $15,374NPV: $15,374 - $14,000 = $1,658