The Capital City Company (CCC) is considering the purchase of a new laundromat to replace the one currently being used. The present machine is expected to last another seven years and have no salvage value. The laundromat in current use has a book value of $700 and can be sold today for $400. CCC pays $300 a year maintenance on the press. The new laundromat will cost $1,500. It is expected to last seven years, at which time it will be sold for $100. The maintenance cost of the new machine is expected to be $150 a year. CCC depreciates its assets on the straight-line basis and pays 30% taxes. If its opportunity cost of funds is 10%, should it buy the new machine?
Answer:
Initial cost $1,500
less sale of old machine -400
loss on sale 700 – 400 = 300
tax recovered 300 x 0.30 = + 90
$1,190
Annual savings after tax = ($300 – $150)(0.70)
= $105
Change in depreciation = ($1,500 – $100)/7 – $700/7 = $100 per yr
Tax saving on depr. change = ($100)(0.30)
= $30
NPV at 10% = ($105 + $30)(4.868) + ($100)(0.513) – $1,190 = -$481.52
Since the NPV is negative, we would REJECT this project at this time.
