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    Compute Net Present Value

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    Dungan Corporation is evaluating a proposal to purchase a new drill press to replace a less efficient machine presently in use. THe cost of the new equipment at time 0, including delivery and installation, is $200,000. If it is purchased, Dunagn will incur costs of $5,000 to remove the present equipment and revamp its facilities. This $ 5,000 is tax deductible at time 0.
    Depreciation for tax purposes will be allowed as follows: year 1, $40,000; year 2, $70,000; and in years 3 through 5, $30,000 per year. The existing equipment has a book and tax value of $100,000 and a remaining useful life of 10 years. However, the exisiting equipment can be sold for only $40,000 and is being depreciated for book and tax purposes using the straight-line method over its actual life.
    Management has provided you with the following comparative manufacturing cost data:

    Present Equipment New Equipment
    Annual capacity (units)............ 400,000 400,000
    Annual costs:
    Labor........................... 30,000 25,000
    Depreciation.................... 10,000 14,000
    Other (all cash)................ 48,000 20,000
    Total annual costs................. $ 88,000 $ 59,000

    The existing equipment is expected to have a salvage value equal to its removal costs at the end of 10 years. The new equipment is expected to have a salvage value of $ 60,000 at the end of 10 years, which will be taxable, and no removal costs. No changes in working capital are required with the purchase of the new equipment. The sales force does not expect any change in the volume of sales over the next 10 years. The company's cost of capital is 15 percent, and its tax rate is 45 percent.

    a. Calculate the removal costs of the existing equipment net of tax
    b. Compute the depreciation tax shield.
    c. Compute the forgone tax benefit of the old equipment.
    d. Calculate the cash inflow, net of taxes, from the sale of the new
    equipment in 10 years.
    e. Calculate the tax benefit arising from the loss on the old equipment.
    f. Compute the annual differential cash flows arising from the investment
    in years 1 through 10.
    g. Compute the net present value of the project.

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    Solution Summary

    The expert computes net present values for Dungan Corporation.