Exercise-17 (After-tax cash flows in net present value analysis)

The Falcon company is considering to purchase a printing machine. The relevant information is given below:

• Cost of the printing machine: $150,000
• Annual cash inflows: $45,000
• Useful life of printing machine: 15 years
• Salvage value (Residual value) after 15-year period: $10,000
• Annual cash expenses: $5,000

Falcon company uses straight line method of depreciation. Salvage value is not taken into account for calculating depreciation for tax purposes. Tax rate of Falcon is 30% . Company requires a 14% after-tax return on all investments.

Required: Compute net present value of the printing machine.

Solution:

Net annual cash inflow = Annual cash inflow – Annual cash expenses
= $45,000 – $5,000
= $40,000

*Value from “present value of an annuity of $1 in arrears table“.
**Tax savings from depreciation tax shield – depreciation is a tax deductible expense.

The printing machine has a positive net present value of $40,402 that makes it an acceptable investment.