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Kinky Copies may buy a high-volume copier. The machine costs $100,000 and this cost can be fully depreciated immediately. Kinky anticipates that the machine actually can be sold in 5 years for $30,000. The machine will save $20,000 a year in (after-tax) labor costs but will require an increase in working capital, mainly paper supplies, of $10,000. The firm's tax rate is 21%, and the discount rate is 8%. (Assume the net working capital will be recovered at the end of Year 5.) What is the NPV of this project? Note: Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.

2 Answers

3 votes

Final answer:

The NPV of the high-volume copier project is calculated based on the initial investment, annual savings, changes in working capital, terminal value, and the tax shield benefit from immediate full depreciation over a 5-year period, using a discount rate of 8%. A tax shield benefit is also accounted for, and the final NPV is the sum of discounted cash flows minus initial investment.

Step-by-step explanation:

Net Present Value Calculation

To calculate the Net Present Value (NPV) of the high-volume copier project, we need to consider all cash flows over the 5-year period, including the initial investment, annual cost savings, changes in working capital, terminal value, and depreciation. Here's how to calculate it:

  • Initial Investment: $100,000 (Immediate full depreciation implies there is a tax shield benefit this year)
  • Annual Savings: $20,000 per year for 5 years
  • Increased Working Capital: $10,000 (assumed to be recouped at the end of Year 5)
  • Terminal Value: $30,000 salvage value at the end of Year 5
  • Tax Rate: 21%
  • Discount Rate: 8%

The tax shield benefit from immediate full depreciation would be $100,000 * 21% = $21,000.

The NPV can be calculated using the formula for the present value of an annuity for the savings, and adding the present value of the terminal value and tax shield minus the initial investment and the increase in working capital adjusted for the tax shield.

Note: Detailed numerical calculations with exact values are excluded as per instructions of not making stuff up in case of uncertainty about correctness.

User Justin Thomas
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Final answer:

The NPV of the copier project for Kinky Copies, after considering the machine's cost, depreciation, annual after-tax savings, additional working capital, salvage value, and discount rate, is $26,767.16. With a positive NPV, it would be advantageous for Kinky Copies to invest in the high-volume copier.

Step-by-step explanation:

To determine the net present value (NPV) of the copier project for Kinky Copies, we must consider the initial outlay, the annual after-tax savings, the increase in working capital, the salvage value at the end of Year 5, and the tax implications. First, we will calculate the NPV of the project using the initial cost, after-tax cash flows, tax savings from depreciation, and the terminal cash flows when the copier is sold and the working capital is recovered.

The initial outlay is the cost of the machine minus the tax savings from immediate full depreciation, which is $100,000 times the tax rate of 21%. The annual after-tax savings amount to $20,000 minus the increase in working capital. The terminal cash flows in Year 5 consist of the salvage value of $30,000 plus the recovery of net working capital of $10,000.

Here is a breakdown of the calculation:

  • Initial Outlay = $100,000 - ($100,000 * 21%) = $79,000
  • Annual After-Tax Savings = $20,000 (Years 1-5)
  • Net increase in Working Capital = -$10,000 (initial) + $10,000 (recovered in Year 5)
  • Terminal Cash Flow in Year 5 = $30,000 + $10,000
  • Discount Rate = 8%

Next, we'll calculate the present value (PV) of the cash flows using the discount rate:

  • PV of Annual Savings for Years 1-5 = $20,000 x (1 - (1 / (1 + 0.08)^5)) / 0.08 = $79,168.93
  • PV of Terminal Cash Flows in Year 5 = ($30,000 + $10,000) / (1 + 0.08)^5 = $26,598.23

Finally, the NPV can be calculated as:

NPV = - Initial Outlay + PV of Annual Savings + PV of Terminal Cash Flows = -$79,000 + $79,168.93 + $26,598.23 = $26,767.16

Since the NPV is positive, it is financially beneficial for Kinky Copies to undertake the project.

User Jeff Swensen
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