Stanton Inc. is considering the purchase of a new machine which will reduce manufacturing costs by $5,000 annually and increase earnings before depreciation and taxes by $6,000 annually. Stanton will use the MACRS method to depreciate the machine, and it expects to sell the machine at the end of its 5-year operating life for $10,000 before taxes. Stanton's marginal tax rate is 40 percent, and it uses a 9 percent cost of capital to evaluate projects of this type. If the machine's cost is $40,000, what is the project's NPV?

Question

Quizplus · Accepted Answer

The NPV is calculated by considering the cash flows from cost savings, tax savings from depreciation, and the terminal value, all discounted at the cost of capital. The annual cash flow is $6,000 (earnings increase) - $2,400 (tax on earnings increase) + $2,000 (tax savings from depreciation). The terminal cash flow is $10,000 - $4,000 (tax on sale). Discount these cash flows at 9% and subtract the initial investment of $40,000 to find the NPV.