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.
- What is the amount of annualdepreciation on the new equipment?
- How much tax does this new investmentsave per year from recording depreciationexpense?
- 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]
- Is the purchase of this machine acceptable based on itsNPV?
