If Lew's Steel Forms purchases $618,000 of new equipment,they can lower annual operating costs by $265,000.The equipment will be depreciated straight-line to a zero book value over its 3-year life.Ignore bonus depreciation.At the end of the three years,the equipment will be sold for an estimated $60,000.The equipment will require the company to hold an extra $23,000 of inventory over the 3-year period.What is the NPV if the discount rate is 14 percent and the tax rate is 21 percent?

Question

Quizplus · Accepted Answer

Step 1: Calculate the annual cash flows:
Annual savings = $265,000
Depreciation expense = $618,000/3 = $206,000 per year
Tax savings from depreciation = $206,000 × 0.21 = $43,260 per year
Incremental inventory = $23,000 × (1 + 0.21) = $27,830 (since it is tax-deductible)
Total annual cash flow = $265,000 + $43,260 - $206,000 - $27,830 = $74,430

Step 2: Calculate the present value of each cash flow:
PV of annual cash flows:
Year 1: $74,430/(1 + 0.14)¹ = $65,175.44
Year 2: $74,430/(1 + 0.14)² = $57,006.67
Year 3: $74,430/(1 + 0.14)³ + $60,000/(1 + 0.14)³ = $51,326.22 + $38,871.96 = $90,198.18
Total PV of cash flows = $65,175.44 + $57,006.67 + $90,198.18 = $212,380.29

Step 3: Calculate the NPV:
NPV = -$618,000 + $212,380.29 = -$405,619.71
Since the NPV is negative, the project should not be accepted. Therefore, the best choice is B, which is the only option that provides a negative NPV.

If Lew's Steel Forms Purchases $618,000 of New Equipment,they Can