So the book value of the equipment at the end of

So, the book value of the equipment at the end of three years, which will be the initial investment
minus the accumulated depreciation, is:
Book value in 3 years = $3,950,000 – ($1,316,535 + 1,755,775 + 584,995)
Book value in 3 years = $292,695
The asset is sold at a gain to book value, so this gain is taxable.
Aftertax salvage value = $575,000 + ($292,695 – 575,000)(.35)
Aftertax salvage value = $476,193

CHAPTER 8 B-198
To calculate the OCF, we will use the tax shield approach, so the cash flow each year is:
OCF = (Sales – Costs)(1 – t
C
) + t
C
Depreciation
Year Cash Flow
0 – $4,400,000 = – $3,950,000 – 450,000
1 1,578,787 = $1,720,000(.65) + .35($1,316,535)
2 1,732,521 = $1,720,000(.65) + .35($1,755,775)
3 2,248,942 = $1,837,500(.65) + .35($584,995) + $450,000 + 476,193
Remember to include the NWC cost in Year 0, and the recovery of the NWC at the end of the project.
The NPV of the project with these assumptions is:
NPV = – $4,400,000 + ($1,578,787/1.10) + ($1,732,521/1.10 2 ) + ($2,248,942/1.10 3 )
NPV = $156,759.92
6. First, we will calculate the annual depreciation of the new equipment. It will be:
Annual depreciation charge = $625,000/5
Annual depreciation charge = $125,000
The aftertax salvage value of the equipment is:
Aftertax salvage value = $60,000(1 – .35)
Aftertax salvage value = $39,000
Using the tax shield approach, the OCF is:
OCF = $235,000(1 – .35) + .35($125,000)
OCF = $196,500
Now we can find the project IRR. There is an unusual feature that is a part of this project. Accepting
this project means that we will reduce NWC. This reduction in NWC is a cash inflow at Year 0. This
reduction in NWC implies that when the project ends, we will have to increase NWC. So, at the end
of the project, we will have a cash outflow to restore the NWC to its level before the project. We also
must include the aftertax salvage value at the end of the project. The IRR of the project is:
NPV = 0 = – $625,000 + 55,000 + 196,500(PVIFA
IRR%,5
) + [($39,000 – 55,000)/(1 + IRR) 5 ]
IRR = 20.90%
7. First, we will calculate the annual depreciation of the new equipment. It will be:
Annual depreciation = $267,000/5
Annual depreciation = $53,400
Now, we calculate the aftertax salvage value. The aftertax salvage value is the market price minus (or
plus) the taxes on the sale of the equipment, so:
Aftertax salvage value = MV + (BV – MV) t
c

CHAPTER 8 B - 199
Very often, the book value of the equipment is zero as it is in this case. If the book value is zero, the
equation for the aftertax salvage value becomes:
Aftertax salvage value = MV + (0 – MV) t
c
Aftertax salvage value = MV(1 – t
c
)
We will use this equation to find the aftertax salvage value since we know the book value is zero. So,
the aftertax salvage value is:
Aftertax salvage value = $30,000(1 – .34)
Aftertax salvage value = $19,800
Using the tax shield approach, we find the OCF for the project is:
OCF = $87,000(1 – .34) + .34($53,400)
OCF = $75,576
Now we can find the project NPV. Notice that we include the NWC in the initial cash outlay. The
recovery of the NWC occurs in Year 5, along with the aftertax salvage value.
NPV = – $267,000 – 11,000 + 75,576(PVIFA
10%,5
) + [($19,800 + 11,000)/1.10 5 ]
NPV = $27,616.88
8. To find the BV at the end of four years, we need to find the accumulated depreciation for the first four
years. We could calculate a table with the depreciation each year, but an easier way is to add the
MACRS depreciation amounts for each of the first four years and multiply this percentage times the
cost of the asset. We can then subtract this from the asset cost. Doing so, we get:
BV