Homework SourseThe COO of AppleLike Inc is considering an investment in a n
The COO of AppleLike Inc. is considering an investment in a new machine for iPadLike production. The machine costs $420,000. The COO expects to make iPadLikes on this machine for 6 years, and then he will no longer use the machine. Revenues are expected to be $100,000 each year for this machine. The machine is also expected to decrease production costs of the company by $35,000 per year. There is no net change in working capital due to the new machine. The market value of the machine in 6 years is expected to be $15,000. The company will depreciate the machine using straight-line depreciation, the corporate tax rate is 20%, and the required rate of return demanded by the company on any capital expenditure is 18%. Should the company buy the machine? Provide the NPV to justify your choice.
Solution
Since NPV of the project is positive, the company should buy the machine
| Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | |
| Increase in revenue (A) | 100,000 | 100,000 | 100,000 | 100,000 | 100,000 | 100,000 | |
| Decrease in costs (B) | 35,000 | 35,000 | 35,000 | 35,000 | 35,000 | 35,000 | |
| Net Increase (C=A+B) | 135,000 | 135,000 | 135,000 | 135,000 | 135,000 | 135,000 | |
| Tax on Net Increase @ 20% (D) | 27,000 | 27,000 | 27,000 | 27,000 | 27,000 | 27,000 | |
| After Tax Net Increase (E=C-D) | 108,000 | 108,000 | 108,000 | 108,000 | 108,000 | 108,000 | |
| Tax savings on Depreciation ((420000-15000)/6)*20% (F) | 13,500 | 13,500 | 13,500 | 13,500 | 13,500 | 13,500 | |
| After Tax Salvage Value (15000*(1-0.2)) (G) | 12,000 | ||||||
| Purchase of machine (H) | - 420,000 | ||||||
| Net Cashflows (I=E+F+G+H) | - 420,000 | 121,500 | 121,500 | 121,500 | 121,500 | 121,500 | 133,500 |
| Discounting factor @ 18% (J) | 1 | 0.85 | 0.72 | 0.61 | 0.52 | 0.44 | 0.37 |
| (1/1.18) | (0.85/1.18) | (0.72/1.18) | (0.61/1.18) | (0.52/1.18) | (0.44/1.18) | ||
| Present Value of cashflows (K=I*J) | - 420,000 | 102,966 | 87,259 | 73,949 | 62,668 | 53,109 | 49,453 |
| NPV (Sum of K) | 9,404 |
