Jacuzzi Corporation is considering an investment in equipment for $25,000. Data related to the investment are as follows: $$\begin{array}{l}\begin{array} { c c }
&\text { Cash Flow before }\

\text { Year } & \text { Depreciation and Taxes } \
1 & \$ 12,500 \
2 & 12,500 \
3 & 12,500 \
4 & 12,500
\end{array}
\end{array}$$ Jacuzzi uses the straight-line method of depreciation with no mid-year convention. In addition, its tax rate is 40 percent, and the life of the equipment is four years with no salvage value. Cost of capital is 12 percent. What is the net present value of the investment?

Question

Jacuzzi Corporation is considering an investment in equipment for $25,000. Data related to the investment are as follows: $$\begin{array}{l}\begin{array} { c c } 
&\text { Cash Flow before }\

\text { Year } & \text { Depreciation and Taxes } \
1 & \$ 12,500 \
2 & 12,500 \
3 & 12,500 \
4 & 12,500
\end{array}
\end{array}$$ Jacuzzi uses the straight-line method of depreciation with no mid-year convention. In addition, its tax rate is 40 percent, and the life of the equipment is four years with no salvage value. Cost of capital is 12 percent. What is the net present value of the investment?

Quizplus · Accepted Answer

To calculate the net present value (NPV), first, determine the annual depreciation expense, which is $25,000 / 4 = $6,250. The taxable income each year is $12,500 - $6,250 = $6,250. Taxes paid each year are $6,250 * 40% = $2,500. Thus, the net cash flow after taxes is $12,500 - $2,500 = $10,000. Using the cost of capital (12%) to discount these cash flows back to their present value and subtracting the initial investment gives the NPV. The correct calculation leads to an NPV of approximately $5,370, indicating a profitable investment.

Jacuzzi Corporation Is Considering an Investment in Equipment for $25,000