MakeitRite Company is considering the purchase of a new machine for $80,000. The machine would generate an annual cash flow before depreciation and taxes of $28,778 for five years. At the end of five years, the machine would have no salvage value. The company's cost of capital is 12 percent. The company uses straight-line depreciation with no mid-year convention and has a 40 percent tax rate. What is the net present value for the machine?

Question

Quizplus · Accepted Answer

The net present value (NPV) of the machine can be calculated by first determining the after-tax cash flows and then discounting these cash flows back to their present value at the company's cost of capital. 1. Calculate the annual depreciation: $80,000 / 5 years = $16,000 per year.2. Calculate the annual cash flow before taxes but after depreciation: $28,778 - $16,000 = $12,778.3. Calculate the tax on the cash flow: $12,778 * 40% = $5,111.2.4. Calculate the after-tax cash flow: $12,778 - $5,111.2 = $7,666.8.5. Add back depreciation (since it's a non-cash expense) to get the total annual cash flow: $7,666.8 + $16,000 = $23,666.8.6. Discount the annual cash flow back to its present value using the cost of capital (12%) over the 5-year period.7. Subtract the initial investment ($80,000) from the total present value of the cash flows to get the NPV.The correct NPV calculation involves considering the tax shield from depreciation and the cost of capital to discount future cash flows. The option that closely matches the result of a correct NPV calculation, given the provided data, is $5,318, indicating that the investment would add value to the company.

MakeitRite Company Is Considering the Purchase of a New Machine