CMA Study Group

NPV

  • 1.  NPV

    Posted 05-02-2020 12:20 PM
    Hi!

    Effective tax rate = 40% Cost of capital = 12%

    Data regarding the the existing and new machine is given:

                                                       Existing machine    New machine
    Original cost                                         50,000               90,000
    Installation cost                                         0                      4,000
    Freight and insurance                               0                      6,000
    Expected salvage value                            0                         0
    Depreciation method                        Straight line          Straight line
    Expected useful life                              10 years               5 years


    The existing machine has been in service for 7 years and could be sold for $25,000 currently. The expected before tax annual reduction in labor costs is $30,000 if the new machine is purchased. 
    If the new machine is purchased, what is  the incremental after tax cash flow for the fifth year?

    Answer: $26,000

    When  calculating the depreciation tax shield, why is the change in depreciation amount (or  the difference between the old and new machine's depreciation) not used? 

    Thank you!



  • 2.  RE: NPV

    Posted 05-03-2020 01:11 AM
    because by year 5, old machine is fully used up. the incremental depreciation will be the full depreciation of new machine in year 5.


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    Muhammad
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  • 3.  RE: NPV

    Posted 05-03-2020 01:21 AM
    Hi Shri,

    The questions asked about incremental cash flow at fifth year only.
    Labor cost  reduction= 30,000 x .60=18,000.00
    Depreciation= 100,000/5= 20,000 x .40 = 8,000.00
    Total 26,000.00
    The difference between old and new machine will not come in Fifth year cash flow.
    If i am wrong, pls. correct me.
    Thank you,

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    Arunkumar Krishnan
    Accountant
    Al-Yusr Industrial Contracting Co.
    Yanbu
    Saudi Arabia
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  • 4.  RE: NPV

    Posted 05-06-2020 12:57 AM
    Thank you!