Maroon Company is considering the purchase of equipment for $600,000.The equipment will have a ten year life with no terminal salvage value.Straight-line depreciation will be used for tax purposes.It is expected that the equipment will generate annual sales of $400,000 for ten years and annual production costs,exclusive of depreciation,of $300,000 for ten years.The tax rate is 20%.The required rate of return is 12%.The present value of one for ten periods at 12% is 0.322.The present value of an ordinary annuity of one for ten periods at 12% is 5.6502.What is the net present value of the equipment?

Question

Quizplus · Accepted Answer

Annual cash inflows (sales) = $400,000
Annual cash outflows (excluding depreciation) = $300,000
Annual depreciation = $600,000/10 = $60,000
Taxable income = $40,000 ($400,000 - $300,000 - $60,000)
Tax expense = $8,000 (20% of $40,000)
After-tax cash inflow = $392,000 ($400,000 - $8,000)

Using the formula for the present value of an annuity:

PV annuity = $392,000 x 5.6502 = $2,211,684.8

Using the formula for the present value of a single amount:

PV single = $600,000 x 0.322 = $193,200

Net present value = PV annuity + PV single - Initial investment
Net present value = $2,211,684.8 + $193,200 - $600,000
Net present value = $1,804,884.8

Since the net present value is negative, the equipment should not be purchased. However, none of the answer choices reflect a negative net present value. Therefore, the best choice would be the option with the closest numerical value to the calculated net present value, which is answer choice A) $(80,182).

Maroon Company Is Considering the Purchase of Equipment for $600,000