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A company is considering the purchase of equipment costing $84000 which will permit it to reduce its existing labour cost by $21000 each year for twelve years
A company is considering the purchase of equipment costing $84000 which will permit it to reduce its existing labour cost by $21000 each year for twelve years. The company estimates that it will have to spend $2000 every two years overhauling the equipment. The equipment may be depreciated using straight line depreciation over 12 years for tax purposes. The company tax rate is 30 cents in the dollar and the after corporate tax cost of capital is 10% per annum.
Assume:
1. Salvage value of zero.
2. The outlay of $84000 occurs at time zero.
3. All other cash flows including, tax payments and credits are made at the end of the year.
4. No overhaul is required in year 12.
What is the NPV to the nearest dollar?
Expert Solution
NPV= $26374
Workings
Labour cost saving is after tax = 21000*(1-30%)
Overhaul cost is after tax
Tax shield on depreciation = Initial cost*Tax rate/12
| Year | Initial cost | Labour cost after tax | Overhaul cost | Tax shield on depreciation | Net cash flow |
| 0 | -84000 | -84000 | |||
| 1 | 14700 | 2100 | 16800 | ||
| 2 | 14700 | -1400 | 2100 | 15400 | |
| 3 | 14700 | 2100 | 16800 | ||
| 4 | 14700 | -1400 | 2100 | 15400 | |
| 5 | 14700 | 2100 | 16800 | ||
| 6 | 14700 | -1400 | 2100 | 15400 | |
| 7 | 14700 | 2100 | 16800 | ||
| 8 | 14700 | -1400 | 2100 | 15400 | |
| 9 | 14700 | 2100 | 16800 | ||
| 10 | 14700 | -1400 | 2100 | 15400 | |
| 11 | 14700 | 2100 | 16800 | ||
| 12 | 14700 | 2100 | 16800 | ||
| NPV | 26373.64 |
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