Photographic laboratories recover and recycle the silver used in photographic fi

Question

Photographic laboratories recover and recycle the silver used in photographic film. Stikine River Photo is considering purchase of improved equipment for their laboratory at Telegraph Creek. Here is the information they have:

  

Silver is selling for $23 per ounce. Over the past 5 years, the price of silver has appreciated by 4.5% per year in real terms. Silver is traded in an active, competitive market.

  
What is the NPV of the new equipment?

• The equipment costs $101,500 and will cost $81,200 per year to run. • It has an economic life of 10 years but can be depreciated over five years by the straight-line method. • It will recover an additional 5,000 ounces of silver per year. •

Silver is selling for $23 per ounce. Over the past 5 years, the price of silver has appreciated by 4.5% per year in real terms. Silver is traded in an active, competitive market.

• Stikine's marginal tax rate is 30%. Assume U.S. tax law. • Stikine's company cost of capital is 7% in real terms. • The nominal interest rate is 5%.

Explanation / Answer

Answer:

Assumptions Equipment cost $101,500 Annual cost to operate $81,200 Depreciation (years 1-5) $20,300 Silver ounces per year 5,000 Silver price per ounce $23 Marginal tax rate 30% Cost of capital (real) 7% What is the NPV of the new equipment? Make additional assumptions as necessary. Assumed nominal cost of capital: 5% Net Present Value Present value of tax shield               26,367 Present value of silver             805,000 Present value of operating costs           (399,220) Less: equipment costs ($101,500) Net Present Value             330,646

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