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A firm has purchased for $14,000 a machine with a five year useful life. The machine...

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Finance

A firm has purchased for $14,000 a machine with a five yearuseful life. The machine will be
depreciated using ADS on a three-year depreciation schedule. Theuniform annual benefits are
$3600. The firm’s effective tax rate is 47% and the MARR before taxis 10%. The firm estimates
that there is a 40% likelihood that the machine will have a salvagevalue of $5,000 and
due to the probability of obsolescence, a 60% likelihood that themachine will have no salvage
value. Determine if this is a satisfactory investment.

Answer & Explanation Solved by verified expert
4.4 Ratings (742 Votes)

DEPRECIATION TAX SHIELD
3 Year ADS depreiation:
Cost of Asset $14,000 Tax Rate=47%
A B=A*$14000 C=B*47%
Year Recovery Rate Annual Depreciation Depreciation Tax shield
1 16.67% $2,334 $1,097
2 33.33% $4,666 $2,193
3 33.33% $4,666 $2,193
4 16.67% $2,334 $1,097
Salvage Value: Probability Salvage Value*Probability
$5,000 40.00% $2,000
$0 60.00% $0
SUM $2,000
Expected Salvage Value $2,000
After tax Salvge value=2000*(1-0.47)= $1,060
After Tax MARR =10*(1-0.47)= 5.30%
Present Value of Cash Flow
(Cash Flow)/((1+i)^N)
i= Discount Rate= MARR=5.3%=0.053
After Tax annual benefit =3600*(1-0.47) $1,908
N Year 0 1 2 3 4 5
A Initial Cash Flow ($14,000)
B AnnualBenefit(after tax) $1,908 $1,908 $1,908 $1,908 $1,908
C Depreciation tax shield $1,097 $2,193 $2,193 $1,097
D After tax salvage value $1,060
E=A+B+C+D Net cash flow ($14,000) $3,005 $4,101 $4,101 $3,005 $2,968 SUM
PV=E/(1.053^N) PresentValue of Cash Flow ($14,000) $2,854 $3,699 $3,513 $2,444 $2,293 $801
NPV=Sumof PV Net Present Value $801
Yes, It is a satisfactory investment
NPV is positive

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Transcribed Image Text

A firm has purchased for $14,000 a machine with a five yearuseful life. The machine will bedepreciated using ADS on a three-year depreciation schedule. Theuniform annual benefits are$3600. The firm’s effective tax rate is 47% and the MARR before taxis 10%. The firm estimatesthat there is a 40% likelihood that the machine will have a salvagevalue of $5,000 anddue to the probability of obsolescence, a 60% likelihood that themachine will have no salvagevalue. Determine if this is a satisfactory investment.

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