Alexander Manufacturing is planning to purchase a machine costing $185,000 to replace fully depreciated production equipment. Alexander expects to receive $2,200 through the sale of the old equipment, which was purchased six years ago for $137,000. For the duration of the new machine's useful life, Alexander estimates needing to commit working capital of $6,000. The new equipment will be depreciated by the straight-line method over a four-year life with a salvage value of $25,000. Management estimates that investing in this machine will increase annual net after-tax cash flows by $70,000 (which includes the tax shield effect of depreciation). Calculate the net present value for the investment opportunity, assuming a 40% income tax rate and an 8% hurdle rate.*
Ans : 64955
Explanation given : The NPV for the investment opportunity:
Calculator steps: Clear All
- Enter 4 in the N key
- Enter 8 in the I/YR key
- Enter 70,000 in the PMT key
- Enter 31,000* in the FV key
- Compute PV → –254,635** is the present value solution.
Net present value = $254,635 – ($185,000 + $6,000 – 1,320***) = $64,955.
*Released working capital of $6,000 + Salvage value of $25,000 = $31,000.
**The present value is negative because the calculator is indicating that $254,635 current investment (outflow) is equal to all the future inflows (positive payments), assuming an 8% discount rate.
*** After-tax cash on the sale of the old machine at Time 0 = $2,200 × (1 – 40%) = $1,320.
My question is why salvage value hasnt taken tax effect of 40 %?