Quip Corporation wants to purchase a new machine for $300,000.Management predicts that the machine can produce sales of $200,000 each year for the next 5 years.Expenses are expected to include direct materials,direct labor,and factory overhead (excluding depreciation)totaling $80,000 per year.The firm uses the straight-line depreciation and expects the machine to have a residual value of $50,000.Quip's tax rate is 40%.Management requires a minimum of 10% return on all investments.What is the investment's net present value (NPV)of the proposed investment (rounded to the nearest hundred)? (The PV annuity factor for 10%,5 years,is 3.791 and for 4 years it is 3.17.The present value factor for 10%,5 years,is 0.621. )Assume that cash inflows occur at year-end.

Question

Quizplus · Accepted Answer

1. Calculate the annual cash inflows: $200,000 - $80,000 = $120,000
2. Calculate the total cash inflows over the 5 years: $120,000 x 5 = $600,000
3. Calculate the annual depreciation: ($300,000 - $50,000) / 5 = $50,000
4. Calculate the annual taxable income: $120,000 - $50,000 = $70,000
5. Calculate the annual tax payment: $70,000 x 40% = $28,000
6. Calculate the annual after-tax cash inflows: $120,000 - $28,000 = $92,000
7. Calculate the present value of the after-tax cash inflows: $92,000 x 3.791 x 0.621 = $210,768
8. Calculate the present value of the initial investment: $300,000 x 0.621 = $186,300
9. Calculate the net present value: $210,768 - $186,300 = $24,468
10. Since the NPV is positive, the investment should be accepted as it is expected to generate a return of at least 10%. Rounded to the nearest hundred, the NPV is $79,800.

Quip Corporation Wants to Purchase a New Machine for $300,000