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For example, Adelphi, Inc., is considering the purchase of a machine that would cost $370,000 now,...

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Accounting

For example, Adelphi, Inc., is considering the purchaseof a machine that would cost $370,000 now, and would last for 8years. At the end of 8 years, the machine would have a salvage(disposal) value of $50,000.
The machine would reduce labor and other costs by $60,000 per year.All cost savings are assumed to occur at the end of eachyear.
Additional working capital of $5,000 would be needed immediately.All of this working capital would be recovered in cash at the endof the life of the machine.

The company requires a minimum pretax return of 10% onall investment projects.


The company has a 21% tax rate and uses the straight-linedepreciation method.

  1. What is the amount of annualdepreciation on the new equipment?
  2. How much tax does this new investmentsave per year from recording depreciationexpense?
  3. What is the amount of periodic annualafter-tax net cash-flow from the use of this new machine?[Cash from depreciation tax shield and after-tax cash flow fromcost savings]
  4. Is the purchase of this machine acceptable based on itsNPV?

Answer & Explanation Solved by verified expert
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Part 1
Annual Depreciation for equipment $   40,000
($370,000-$50,000)/8 Years
Part 2
Annual Depreciation for equipment $   40,000
Tax Savinng on Depreciation 21% $     8,400
Part 3
After tax saving in Cost $60,000*(1-0.21) $   47,400
Add: Tax savining on Depreciation $     8,400
Annual after tax cash flow $   55,800
Part 4
Cash Flow PVF PV
Present value of Annual after tax cash flow $   55,800      5.3349 $ 297,687
Present value of salvage value $   50,000      0.4665 $    23,325
Less: Initial Investment $-370,000
NPV $ -48,988
No, since NPV is negative

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