# Net present value of this investment proposal

(See attached file for full problem description)

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3. As you checked "Your Professor's answer" to the Self-Check Excercise problem 6 from this lesson (lesson 16) you will note that each year's net cash flows are calculated by adding depreciation back to net earnings. On the other hand, problem 1 in this assignment specifies a series of steps that leads you through the same approach as that used in "Your Professor's answer" for problem 8 of this lesson. Rework and submit problem 6 of lesson 16 using the same approach to calculate each year's after-tax cash flows as is used in the "Your Professor's answer" to solve problem 8 of Lesson 16. That is, calculate the after-tax cash flows as if there were no non-cash expenses. Then, adjust these after-tax cash flows for the tax credits resulting from the non-cash tax shields. (This is the method problem 1 above leads you through as you follow the specified steps a through k for solving that problem). Carefully examine the solution to problem 6, lesson 16, in "Your Professor's answer," but solve it using this alternative method. Be sure to check your answer. If you get a different answer than "Your Professor's answer" gives for problem 6, you have made an error.

1. The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $120,000. Of this amount, $70,000 is subject to five-year MACRS depreciation. The balance is in nondepreciable property. The contract covers six years. At the end of six years, the non-depreciable assets will be sold for $50,000. The depreciated assets will have zero resale value.

The contract will require an investment of $55,000 in working capital at the beginning of the first year, and, of this amount, $25,000 will be returned to the Spartan Technology Company after six years.

The investment will produce $50,000 in income before depreciation and taxes for each of the six years. The corporation is in a 40 percent tax bracket and has a 10 percent cost of capital.

BELOW IS QUESTION 8 WITH ANSWER AS AN EXAMPLE

The Acme Corporation is considering the purchase of an additional lathe to handle periodic overload conditions in the shop. By reducing overtime premiums, purchase of this lathe will result in cash savings of $20,000 per year before taxes. The new lathe would cost $50,000 and would have a useful life of 5 years. The lathe would be depreciated straight line to a zero salvage value over its useful life of 5 years. (It really wouldn't, but let's say it would. It is easier that way!)

Using a separate piece of paper or a computer spreadsheet, calculate the after-tax cash flows for this investment proposal using the method described in the discussion material for this lesson. That is, calculate the after-tax cash flows as if there were no non-cash expenses. Then adjust these after-tax cash flows for the tax credits resulting from the non-cash tax shields. Calculate the net present value of this investment proposal using a 15% discount rate. Acme's marginal tax rate is 40%.

ANSWER

1. Your Professor's answer:

Problem 8

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

EBIDT 20,000 20,000 20,000 20,000 20,000

(1)After tax @ 40% tax rate 12,000 12,000 12,000 12,000 12,000

Depreciation 10,000 10,000 10,000 10,000 10,000

(2)Depreciation tax credit 4,000 4,000 4,000 4,000 4,000

Cashflow (1) + (2) 16,000 16,000 16,000 16,000 16,000

Investment -50,000

NPV= 3,634 @ 15% cost of capital

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#### Solution Preview

3. As you checked "Your Professor's answer" to the Self-Check Excercise problem 6 from this lesson (lesson 16) you will note that each year's net cash flows are calculated by adding depreciation back to net earnings. On the other hand, problem 1 in this assignment specifies a series of steps that leads you through the same approach as that used in "Your Professor's answer" for problem 8 of this lesson. Rework and submit problem 6 of lesson 16 using the same approach to calculate each year's after-tax cash flows as is used in the "Your Professor's answer" to solve problem 8 of Lesson 16. That is, calculate the after-tax cash flows as if there were no non-cash expenses. Then, adjust these after-tax cash flows for the tax credits resulting from the non-cash tax shields. (This is the method problem 1 above leads you through as you follow the specified steps a through k for solving ...

#### Solution Summary

This explains the computation of net present value of investment proposal