Warner Corporation is considering the acquisition of a new machine that costs $350,000. The machine is expected to have a four-year service life and will produce annual savings in cash operating costs of $100,000. Warner uses the optional straight-line method of depreciation and depreciates the asset over its four-year service life. The company is subject to a 30% income tax rate, has an after-tax hurdle rate of 12%, and rounds calculations to the nearest dollar.YearFV of $1 at 12%FV of an ordinary annuity at 12% PV of $1 at 12%PV of an ordinary annuity at 12% 11.1201.0000.8930.89321.2542.1200.7971.69031.4053.3740.7122.40241.5744.7790.6363.03751.7626.3530.5673.60561.9748.1150.5074.111Required:A. Determine the annual after-tax cash flows that result from acquisition of the machine.B.
Calculate the machine's net present value. Is the machine an attractive investment? Why?
What will be an ideal response?
A. Annual cash operating costs: $(100,000) × 0.7 = $(70,000)
Depreciation tax savings:
Year 1: $43,750 × .3 = 13,125
Year 2: $87,500 × .3 = 26,250
Year 3: $87,500 × .3 = 26,250
Year 4: $87,500 × .3 = 26,250
Year 5: $43,750 × .3 = 13,125
B.
| Initial investment | $(350,000) × 1.0 | $(350,000) | |
| Cash operating savings | $70,000 × 3.037 | 212,590 | |
| Depreciation tax shield | ? | ? | |
| Year | 1 | 13,125 × 0.893 | 11,721 |
| ? | 2 | 26,250 × 0.797 | 20,921 |
| ? | 3 | 26,250 × 0.712 | 18,690 |
| ? | 4 | 26,250 × 0.636 | 16,695 |
| ? | 5 | 13,125 × 0.567 | 7,442 |
| Net present value | ? | $(61,941) |
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