Question 15 Riverview company is evaluating the proposed

Question 15. Riverview company is evaluating the proposed acquisition of a new production machine. The machine’s base price is $200, 000 and installation costs would amount to $28, 000. Also, 10, 000 in net working capital (NWC) would be required at installation. The machine would save the firm $110, 000 in operating costs. The firm is planning to keep the machine in place for 2 years. At the end of the second year, the machine will be sold for $100, 000. Riverview has a cost of capital of 12% and a marginal tax rate of 34%.

Step 1 A: Calculate net initial outlay • Initial Outlay ($200, 000) • Installation costs (28, 000) ___________________ Depreciable asset (228, 000) • NWC (10, 000) ___________________ Net Initial Outlay ($238, 000) Cash flow 0 = Cfj 0

Step 1 B: Calculate depreciation expense •

Step 2: Calculate the annual cash flow • Operating costs [SAVINGS+] 110, 000 • Depreciation expense (76, 000) ______________________ EBIT (Taxable income) 34, 000 • Tax liability (Taxable income*34%) (11, 560) ______________________ EAT (Operating cash flow) 22, 440 • Depreciation reversal (Add back depreciation) 76, 000 ______________________ ACF (Annual Cash Flow) $98, 440 Cash flow 1 = Cfj 1

Step 3 A: Calculate the tax effect • Salvage value (SV) $100, 000 • Book value (BV) (76, 000) __________________ Proceeds from sale [gain] 24, 000 Tax rate (34%) x 0. 34 __________________ Tax liability (proceeds*34%) $(8, 160)

Step 3 B: Calculate the terminal cash flow • Salvage value (SV) $ 100, 000 • Tax liability (8, 160) • NWC recapture 10, 000 _____________________ $101, 840 Cash flow 1 +98, 440 ______________________ TCF (Terminal cash flow) 200, 280 Cash flow 2 = Cfj 2

Step 4: Calculate NPV • Cfj 0 = ($238, 000) • Cfj 1 = $98, 440 • Cfj 2 = $200, 280 • I/yr = 12% • NPV = 9, 555 üWe only have two cash flows because the company is planning to keep the machine only for 2 years, so we disregard the class life when calculating NPV