Great Northern Fishing Company is contemplating the purchase of a new smoker. The smoker will cost $61,800 but will generate additional revenue of $34,000 per year for 6 years. Additional costs, other than depreciation, will equal $11,400 per year. The smoker has an expected life of 6 years, at which time it will have no residual value. Great Northern uses the straight-line method of depreciation for tax purposes. Determine the net present value of the investment if the required rate of return is 12 percent and the tax rate is 30 percent
| year | Cash
flow |
Exp | Final Cash flow
after Tax 0.70 of net cf + Depri Tax Shelter |
Depriciation
Tax Shelter |
rate 12% | Discounted
Cash Flow |
| 0 | (61800) | 1 | (61800) | |||
| 1 | 34000 | (11400) | 15820+3090 | 18910 | 0.893 | 16886.63 |
| 2 | 34000 | (11400) | 15820+3090 | 18910 | 0.797 | 15071.27 |
| 3 | 34000 | (11400) | 15820+3090 | 18910 | 0.712 | 13463.92 |
| 4 | 34000 | (11400) | 15820+3090 | 18910 | 0.636 | 12026.76 |
| 5 | 34000 | (11400) | 15820 | 18910 | 0.567 | 10721.97 |
| 6 | 34000 | (11400) | 15820+3090 | 18910 | 0.507 | 9587.37 |
| Total | 77757.92
(61,800) |
|||||
| 15957.92 |
Depriciation = value / life of the assets
= 61800 /6
= 10300 depriciation each year
Depriciation tax shelter = Depriciation x Tax Rate
= 10300 x 30 %
= 3090
Conclusion : The company should purchase new machine as the prasent value of cash low is positive
