Ilana Industries, Inc., needs a new lathe. It can buy a new high-speed lathe for
ID: 2745324 • Letter: I
Question
Ilana Industries, Inc., needs a new lathe. It can buy a new high-speed lathe for $2.0 million. The lathe will cost $31,000 per year to run, but it will save the firm $184,000 in labor costs and will be useful for 10 years. Suppose that for tax purposes, the lathe will be depreciated on a straight-line basis over its 10-year life to a salvage value of $470,000. The actual market value of the lathe at that time also will be $470,000. The discount rate is 10%, and the corporate tax rate is 40%. What is the NPV of buying the new lathe? (A negative amount should be indicated by a minus sign. Enter your answer in dollars not in millions. Do not round intermediate calculations. Round your answer to 2 decimal places.)
Explanation / Answer
Workings:
After tax cost advantage = $ ( 184,000 - 31,000) x ( 1-0.4) = $ 91,800
Tax benefit of depreciation = 2,000,000 - 470,000 / 10 = $ 153,000 x 0.4 = $ 61,200
Annual cash savings = $ ( 91,800 + 61,200) = $ 153,000
Present value of cash inflows at 10% discount rate = $ 153,000 x 6.1446 + $ 470,000 x 0.3855 = $ ( 940,123.8 + 181,185) = $ 1,121,309
NPV = $ ( 1,121,309 - 2,000,000) = $ -878,691
NPV $ -878,691.2