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Engineering Company Pty. Ltd. is considering a proposal to purchase an additional spray machine for its repair shop. The finance officer of the company has gathered the following data/ information relevant to the machine.
· Purchase and Installation cost of the machine $ 120,000
· Useful life of the machine 5 Years
· Estimated salvage value at the end of 5 years $ 5,000
· Net cash inflow that will be generated by the machine from end of year 1 to the
end of year 5, before deducting depreciation and income tax, is estimated at $ 40,000 per year.
· Although the machine will have a useful life of 5 years, the Tax Department will
allow the company to fully depreciate the machine in 4 years. To take advantage of this tax rule, the company will depreciate the machine in full over the first 4 years, ignoring the estimated salvage value.
· The new spray machine will require an incremental investment in working
capital of $10,000. This will be fully recovered at the end of the machine’s working life.
· The applicable tax rate for the Engineering Company is 30% and the after-tax required rate of return (cost of capital) is 10%.
You are required to:
i) Calculate the NPV[1]
ii) Make a recommendation based on the NPV
[1]
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