Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 45

Straightforward Capital Budgeting with Taxes; Sensitivity Analysis Dorothy&George Company is planning to acquire a new machine at a total cost of $30,600. The machine’s estimated life is six years and its estimated salvage value is $600. The company estimates that annual cash savings from using this machine will be $8,000. The company’s after-tax cost of capital is 8 percent and its income tax rate is 40 percent. The company uses straight-line depreciation (non-MACRS-based).

Required

1. What is this investment’s net after-tax annual cash inflow?

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2. Assume that the net after-tax annual cash inflow of this investment is $5,000; what is the payback period?

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3. Assume that the net after-tax annual cash inflow of this investment is $5,000; what is the net present value (NPV) of this investment?

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4. What are the minimum net after-tax annual cost savings that make the proposed investment acceptable (i.e., the dollar cost savings that would yield a NPV of $0)?

Step 1 of 6

Capital Budgeting is a process used to evaluate the various available projects to decide which project is to be proceeded with. First of all, we start process of capital budgeting with forecasting of future inflows and outflows of available projects. It is determined that what effect will it make on cash flows of the firm, and then NPV of project is calculated to determine how it would affect the value of firm. Net Present Value (NPV) means difference between present value of all inflows resulting from project and present value of outflows resulting from such project.