Explain to me why salvage value is not taken into consideration for depreciation expense here!? The calc's are based on $150,000 but it has a resale value of $10k. Shouldnt it be based on $140k not the $150k ? Question #: 264 Category: 3A2 Financial and Risk Analysis:
McLean, Inc., is considering the purchase of a new machine that will cost $150,000. The machine has an estimated useful life of three years. Assume for simplicity that the equipment will be fully depreciated 30, 40, and 30% in each of the three years, respectively. The new machine will have a $10,000 resale value at the end of its estimated useful life. The machine is expected to save the company $85,000 per year in operating expenses. McLean uses a 40% estimated income tax rate and a 16% hurdle rate to evaluate capital projects.
Discount rates for a 16% rate are as follows.
Present Value of an
Present Value of $1 Ordinary Annuity of $1
——————- ———————-
Year 1 0.8621 0.8621
Year 2 0.7432 1.6052
Year 3 0.6407 2.2459
What is the net present value of this project?
A.
$15,842
Correct B.
$13,278
C.
$9,432
D.
$(35,454)
Explaination:
To determine the net present value of this project, set up an analysis of cash flows as follows:
Annual Annual Annual Annual
Before Tax Tax Aftertax Aftertax
Cash Flows Savings Cash Flow Net Income
———- ——- ——— ———-
Investment Year 0 (150,000) 0 (150,000) 0
Annual cash savings Year 1-3 85,000 (34,000) 51,000 51,000
Depreciation effect Year 1 18,000 18,000 (27,000)*
Year 2 24,000 24,000 (36,000)**
Year 3 18,000 18,000 (27,000)*
Gain on Disposal Year 3 10,000 (4,000) 6,000 6,000
These depreciation effects are calculated as follows:
Yr1 150,000 x .30 (depreciation) x .40 (tax rate) = 18,000
Yr2 150,000 x .40 (depreciation) x .40 (tax rate) = 24,000
Yr3 150,000 x .30 (depreciation) x .40 (tax rate) = 18,000
* 18,000 – (150,000 x .30 depreciation) = (27,000)
** 24,000 – (150,000 x .40 depreciation) = (36,000)
Now determine the Net Present Value of Annual Aftertax Cash Flow by year.
Annual Present Net
Aftertax Value Present
Cash Flow x of $1 = Value
Yrly Total: Yr 0 (150,000) x 1.0000 = (150,000)
Yr 1 (51,000 + 18,000) x 0.8621 = 59,485
Yr 2 (51,000 + 24,000) x 0.7432 = 55,740
Yr 3 (51,000 + 18,000 + 6,000) x 0.6407 = 48,053
——-
Total 13,278
.