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Time value of money

SAC is considering the purchase of new equipment to manufacture specialty spark plugs.
The new equipment would allow the firm to manufacture 100,000 additional spark plugs per year and is expected to have a useful life of 5 years and to have no salvage value at that time.

SAC will depreciate the equipment using the straight-line method. Specialty spark plugs are selling for an average price of $20 and are expected to cost $8 to manufacture with the new equipment. Indirect costs are expected to remain the same.
The equipment will cost $3,000,000 to purchase and install. SAC's tax rate is 34%.

Solution Preview

First we need to determine the incremental operational cash flow using this new equipment.
Incremental revenue = 100,000*$20=$2,000,000
Incremental cost = 100,000*$8=$800,000
Indirect costs remain the same.
Thus, incremental profits = Incremental revenue - Incremental cost = 2,000,000-800,000 = $1,200,000

Depreciation Expense = 3,000,000/5 = ...

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