CORPORATE FINANCE All calculation up to four decimal points Your company is cons
ID: 2767048 • Letter: C
Question
CORPORATE FINANCE All calculation up to four decimal points Your company is considering buying a machine to automate a process and make a cost saving of $700,000 a year. The machine costs S2.000.000 that can be amortized linearly to zero (no salvage value) over the life of the machine which is 5 years. It costs S40.000 a year to operate the machine. The discount rate of the project is 8% which is the same as the cost of borrowing. Your company decides to borrow the money at 8% with payments being made annually. What are the annual payments such that the loan is paid off in 5 years? What is the total interest that is paid over the life of the loan? If the company's tax rate is 2.5%, what is the NPV of this project? What is the minimum cost savings that would justify purchasing the machine?Explanation / Answer
the annual payment required to pay off the loan in 5 years
2000000 = Annuity * PVIFA ( r%, n)
2000000 = Annuity * PVIFA(8%,5)
Annuity = 500912
The total interest paid = total annuity - loan amount
= 500912 * 5 - 2000000 = 504564
The NPV of the project = PV of Cash inflow - PV of cash outflow
= PV of (700000 - 40000)*(1 - 2.5%) - 2000000
= 2569308 - 2000000 = 569308