Miller Ltd has been considering the purchase of a new machine. The existing machine is operable for three more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $35,000. The new machine will cost $180,000 and an additional cash investment in working capital of $25,000 will be required. The new machine will reduce the average amount of time required on the production line and will decrease labour cost. The investmentis expected to net $80,000 in additional cash inflows during the year of acquisition and $120,000 each additional year of use. The new machinehas a three-year live, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. The working capital investment will not be recovered at the end of the asset's life. The equipment would qualify as a class 8 asset (20% dep) and the company will continue to have assets in the pool. Miller's tax rate is 28%. What is the net present value of the investment, assuming the required rate of return is 24%

Question

Miller Ltd has been considering the purchase of a new machine. The existing machine is operable for three more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $35,000. The new machine will cost $180,000 and an additional cash investment in working capital of $25,000 will be required. The new machine will reduce the average amount of time required on the production line and will decrease labour cost. The investmentis expected to net $80,000 in additional cash inflows during the year of acquisition and $120,000 each additional year of use. The new machinehas a three-year live, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. The working capital investment will not be recovered at the end of the asset's life. The equipment would qualify as a class 8 asset (20% dep) and the company will continue to have assets in the pool. Miller's tax rate is 28%. What is the net present value of the investment, assuming the required rate of return is 24%

Answer 1

To calculate the net present value (NPV) of the investment, we need to determine the cash inflows and outflows associated with the new machine over its expected life.

Step 1: Determine the cash inflows:
- In the year of acquisition, the machine is expected to generate an additional cash inflow of $80,000.
- In each subsequent year, the machine is expected to generate an additional cash inflow of $120,000.

Step 2: Determine the cash outflows:
- The cost of the new machine is $180,000.
- An additional cash investment of $25,000 in working capital is required.

Step 3: Determine the salvage value:
- The new machine is assumed to have a zero disposal value.

Step 4: Calculate the present value of cash flows:
- Use the required rate of return of 24% as the discount rate.
- Apply the formula for present value:

PV = CF1 / (1+r) + CF2 / (1+r)^2 + CF3 / (1+r)^3 + ... + CFn / (1+r)^n

Where PV is the present value, CF is the cash flow, r is the discount rate, and n is the year.

In this case, we need to calculate the present value of cash flows for three years (n = 3), with the cash inflows occurring at the end of each year.

PV = $80,000 / (1+0.24) + $120,000 / (1+0.24)^2 + $120,000 / (1+0.24)^3

Step 5: Calculate the net present value (NPV):
- Subtract the initial cash outflow from the present value of cash flows.

NPV = PV - Initial cash outflow
NPV = PV - ($180,000 + $25,000)

After performing the calculations, the net present value of the investment can be determined.