I: Statement of Financial Problem:
In November 1985 Paperco was presented with the critical business decision of replacing its existing mechanical drying equipment that had been originally placed into service in 1979 with more efficient equipment provided by Pressco, Inc. The consequences of this decision would have far reaching consequences as replacing the equipment could result in cost savings up to $560,000 annually. However, there were other critical factors to address before moving forward with the project.
One of the most important factors to consider was the rumored new tax legislation that would, “(1) eliminate the investment tax credit for new equipment; (2) extend depreciation lives for new equipment; and (3) reduce the…show more content… In order to calculate the tax impact of cost savings we utilize a rate of 66% (100% - 34% tax rate) and multiply that by the $560,000. May it be noted that these savings will not begin occurring until the equipment has been in use for an entire year and the old equipment is no longer being used (1986).
* Proceeds from equipment disposal after taxes: iv. In 1986 the existing equipment will be sold, which will have an estimated market value of $150,000 (Table A). This cash inflow will have a positive effect on net cash flow for 1986. v. In 1996 the new equipment will be sold, which will have an estimated salvage value at the end of its useful life of $250,000 (Table B). This cash inflow will also have a positive effect on net cash flow for 1996.
Calculation of NPV based on cash inflows and outflows:
In order to calculate the NPV for the project the sum of the net cash flows for each year must be calculated and multiplied by the present value factor (Table C) for the given cash flow year at 12%. May it be noted that 1985 is considered year 0 and will have a present value factor of 1. Once each years NPV has been calculated, the sum of each year’s NPV is calculated to give us the total NPV for the project, which in this case is equal to $95,680. Since the NPV of the project is greater than zero the project should be accepted.
IV. Assumptions and Special / Mitigating Circumstances: * Equipment cost: $2,100,000. *
