Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $7,800 and sell its old washer for $1,600. The new washer will last for 6 years and save $2,300 a year in expenses. The opportunity cost of capital is 17%, and the firm's tax rate is 21%.

 

a. If the firm uses straight-line depreciation over a 6-year life, what are the cash flows of the project in years 0 to 6? The new washer will have zero salvage value after 6 years, and the old washer is fully depreciated. (Negative amounts should be indicated by a minus sign.)

b. What is project NPV? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

c. What is NPV if the firm investment is entitled to immediate 100% bonus depreciation? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer:

a) Cash Flows

Year 0 = -6536

Year 1 to 6 = 2090

b) NPV

NPV = 965.40

c) NPV Assuming Immediate 100% Bonus Depreciation

NPV = 3357.12

Step-by-step explanation

a) Cash Flows

Cash flow in Year 0 = After Tax Salvage of Old washer - Cost of New Industrial Washer

Cash flow in Year 0 = 1600*(1-21%) - 7800 = -6536

Cash flow in Year 1 to 6 = Savings * (1- tax rate) + Annual Depreciation * Tax rate

Cash flow in Year 1 to 6 = 2300*(1-21%) + 7800/6 * 21% = 2090

b) Net Present Value(NPV)

NPV = Present Value of cash inflows in year 1 to 6 - Cash Flow in Year 0

NPV = 2090 * (1-(1+17%)^-6)/17% -6536 = 965.40

c) NPV Assuming Immediate 100% Bonus Depreciation

Cash flow in Year 0 = After Tax Salvage of Old washer - After tax Cost of New Industrial Washer

Cash flow in Year 0 = 1600*(1-21%) -7800*(1-21%) = -4898

Cash flow in Year 1 to 6 = Savings * (1- tax rate)

Cash flow in Year 1 to 6 = 2300*(1-21%) = 1817

NPV = Present Value of cash inflows in year 1 to 6 - Cash Flow in Year 0

NPV = 2300 * (1-(1+17%)^-6)/17% - 4898 = 3357.12