A Company purchased a new machine with a service life of seven years and no resi
ID: 2549366 • Letter: A
Question
A Company purchased a new machine with a service life of seven years and no residual value on January 1, 20X6, for $400,000. The machine was depreciated using the straight-line method and it was expected to produce annual cash flow from operations, net of income taxes, of $90,000. The present value for an ordinary annuity of $1 for seven periods at 12% is 4.564. The present value of $1 for seven period at 12% is 0.452. Assuming that the company used a rate of return of 12%, what was the net present value on the date of purchase?
Explanation / Answer
Net Present Value on the date of purchase:
Annual cashflow from operations, net of incometaes for 7 years = 90,000
Annuity Present value factor @12% for 7 years = 4.564
Therefore present value of annual cashflows = 90,000 x 4.564 = $ 410,760.
Salvage value = 0.
Cost of purchase = $ 400,000.
Net Present Value on the date of purchase = 410,760 -400,000 = $ 10,760.
Assumption: As annual cash flow from operations, net of income taxes is given, it is assumed that tax shield on depreciation is also included in it.