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    2008-04-13 155702 Kinky

    Uploaded by

    Muhammad Ali Samar
    Kinky Copies is considering purchasing a high-volume copier that costs $100,000 and will be depreciated over 5 years to a $20,000 salvage value. It will save $20,000 per year in labor costs but require $10,000 more in working capital. The NPV is negative $10,894.31, so Kinky Copies should not buy the copier.

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    2008-04-13 155702 Kinky

    Uploaded by

    Muhammad Ali Samar
    121 views2 pages
    Kinky Copies is considering purchasing a high-volume copier that costs $100,000 and will be depreciated over 5 years to a $20,000 salvage value. It will save $20,000 per year in labor costs but require $10,000 more in working capital. The NPV is negative $10,894.31, so Kinky Copies should not buy the copier.

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    Kinky Copies is considering purchasing a high-volume copier that costs $100,000 and will be depreciated over 5 years to a $20,000 salvage value. It will save $20,000 per year in labor costs but require $10,000 more in working capital. The NPV is negative $10,894.31, so Kinky Copies should not buy the copier.

    Copyright:

    © All Rights Reserved
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    121 views2 pages

    2008-04-13 155702 Kinky

    Uploaded by

    Muhammad Ali Samar
    Kinky Copies is considering purchasing a high-volume copier that costs $100,000 and will be depreciated over 5 years to a $20,000 salvage value. It will save $20,000 per year in labor costs but require $10,000 more in working capital. The NPV is negative $10,894.31, so Kinky Copies should not buy the copier.

    Copyright:

    © All Rights Reserved
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    of 2

    Project Evaluation. Kinky Copies may buy a high-volume copier.

    The machine costs


    $100,000 and will be depreciated straight-line over 5 years to a salvage value of $20,000.
    Kinky anticipates that the machine actually can be sold in 5 years for $30,000. The
    machine will save $20,000 a year in labor costs but will require an increase in working
    capital, mainly paper supplies, of $10,000. The firm's marginal tax rate is 35 percent, and
    the discount rate is 8 percent. Should Kinky buy the machine?

    Solution

    The initial investment is $100,000 for the copier plus $10,000 in working capital, for
    a total outlay of $110,000.

    Depreciation expense = ($100,000  $20,000)/5 = $16,000 per year


    Here you have to remember that only the cost of the copier would be depreciated –
    not the Working Capital; and since we are using Straight-line depreciation, we
    subtract the salvage value from the cost to arrive at the Depreciable Cost

    The project saves $20,000 in annual labor costs, so the net operating cash flow
    (including the depreciation tax shield) is:

    $20,000  (1  0.35) + ($16,000  0.35) = $18,600

    In year 5, the copier is sold for $30,000, which generates net-of-tax proceeds of:

    $30,000  (0.35  $10,000) = $26,500


    Remember that the estimated salvage value is $20,000, now since the machine is sold for
    $30,000, then the firm would have to pay taxes on the extra $10,000. Therefore
    Taxable Proceeds = $10,000
    Taxes @ 35% = $10,000 × 35% = $3,500

    the After Tax Proceeds = $30,000 - $3,500 = $26,500

    In addition, the working capital associated with the project is freed up, which releases
    another $10,000 in cash. So, non-operating cash flow in year 5 totals $36,500.
    The NPV is thus:

    NPV = $110,000 + [$18,600  annuity factor(8%, 5 years)] + [$36,500/(1.08)5]

    = $110,000 + $99,105.69 = $10,894.31

    Because NPV is negative, Kinky Copies should not buy the new copier.

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