20 215554 192459 171838 257094 pv of benefit 11158443

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$2,414.20 $2,155.54 $1,924.59 $1,718.38 $2,570.94 PV of benefit $111,584.43 NPV of new equipment $33,584.43 Decision Go 15. b IRR = 18% (used solver to make NPV of new equipment equal zero by changing the discount rate) 15. c Farquarth Manufacturing Company Effective cost of new equipment Depreciation calculation: a. cost of new equipment $90,000.00 Economic life $20.00 b. sale of old equipment $(20,000.00) Salvage value $10,000.00 c. tax on sale $8,000.00 Depreciation per year $4,000.00 Effective cost $78,000.00 Tax rate 40% Discount rate 12% Expected benefit of new equipment Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Profit increase due to new machine $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 $22,000.00 Depreciation tax benefit $(7,619.05) $(7,238.10) $(6,857.14) $(6,476.19) $(6,095.24) $(5,714.29) $(5,333.33) $(4,952.38) $(4,571.43) $(4,190.48) $(3,809.52) $(3,428.57) $(3,047.62) $(2,666.67) $(2,285.71) $(1,904.76) $(1,523.81) $(1,142.86) $(761.90) $(380.95) Profit before tax $14,380.95 $14,761.90 $15,142.86 $15,523.81 $15,904.76 $16,285.71 $16,666.67 $17,047.62 $17,428.57 $17,809.52 $18,190.48 $18,571.43 $18,952.38 $19,333.33 $19,714.29 $20,095.24 $20,476.19 $20,857.14 $21,238.10 $21,619.05 Tax $(5,752.38) $(5,904.76) $(6,057.14) $(6,209.52) $(6,361.90) $(6,514.29) $(6,666.67) $(6,819.05) $(6,971.43) $(7,123.81) $(7,276.19) $(7,428.57) $(7,580.95) $(7,733.33) $(7,885.71) $(8,038.10) $(8,190.48) $(8,342.86) $(8,495.24) $(8,647.62) Profit after tax $8,628.57 $8,857.14 $9,085.71 $9,314.29 $9,542.86 $9,771.43 $10,000.00 $10,228.57 $10,457.14 $10,685.71 $10,914.29 $11,142.86 $11,371.43 $11,600.00 $11,828.57 $12,057.14 $12,285.71 $12,514.29 $12,742.86 $12,971.43 Profit after tax+Depreciation $16,247.62 $16,095.24 $15,942.86 $15,790.48 $15,638.10 $15,485.71 $15,333.33 $15,180.95 $15,028.57 $14,876.19 $14,723.81 $14,571.43 $14,419.05 $14,266.67 $14,114.29 $13,961.90 $13,809.52 $13,657.14 $13,504.76 $13,352.38 Salvage value of new equipment $10,000.00 Inceremental cash flow $16,247.62 $16,095.24 $15,942.86 $15,790.48 $15,638.10 $15,485.71 $15,333.33 $15,180.95 $15,028.57 $14,876.19 $14,723.81 $14,571.43 $14,419.05 $14,266.67 $14,114.29 $13,961.90 $13,809.52 $13,657.14 $13,504.76 $23,352.38 PV factor $0.89 $0.80 $0.71 $0.64 $0.57 $0.51 $0.45 $0.40 $0.36 $0.32 $0.29 $0.26 $0.23 $0.20 $0.18 $0.16 $0.15 $0.13 $0.12 $0.10 Discounted value of benefits $14,506.80 $12,831.03 $11,347.81 $10,035.13 $8,873.48 $7,845.54 $6,936.02 $6,131.33 $5,419.45 $4,789.74 $4,232.74 $3,740.12 $3,304.47 $2,919.24 $2,578.63 $2,277.49 $2,011.28 $1,775.97 $1,567.99 $2,420.87 PV of benefit $115,545.14 NPV of new equipment $37,545.14 Using accelerated depreciation (SYD method), the tax paid initially is smaller compared to straight line and more in later years. Decision Go The NPV is higher using accelerated depreciation. 15. d A long payback period does not mean that it is not a sound investment. Making a capital budgeting decision based on payback rate does not take into consideration the Net Present value of money. In the first six years we may not be able to payback what we spent, but in the long run we will make a profit, especially considering the life of the machine.
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