Net present value with tax effects Branson Manufacturing is considering purchasing a piece of equipment costing $45,000. The new equipment would create a new cash inflow of $20,000 at the end of the year for 5 years. At the end of the 5 years, the equipment would have no salvage value. The company's cost of capital is 10%, and the tax rate is 34%.
Assuming the company uses straight-line depreciation for tax purposes and taking income taxes into account, what is the net present value of purchasing the new equipment?
What Is The Net Present Value:
The Net Present Value analysis is a tool used in a capital budgeting context. The Net Present Value tool quantifies the value, in today's dollars, of an investment and its subsequent cash flows discounted using the firm's cost of capital.
Answer and Explanation:
The after tax cost of capital is = 0.1 *(1-0.34) = 6.6%
Net Present value = PVA(5 years, 6.6%, c=20,000) - cost of machinery
The net present value is positive, the company should thus pursue the investment.
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from Financial Accounting: Help and ReviewChapter 5 / Lesson 20