Quality Chocolate Inc. would like to purchase a new machine for \($200,000.\) The machine will have a life of four years with no salvage value, and is expected to generate annual cash revenue of \($90,000.\) Annual cash expenses, excluding depreciation, will total \($10,000.\) The company uses the straight-line depreciation method, has a tax rate of 30 percent, and requires a 14 percent rate of return.

Required

a. Find the net present value of this investment using the format presented in Table 8.7. Round to the nearest dollar.

b. Should the company purchase the machine? Explain.

Table 8.7

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Net Present Value Calculation with Income Taxes for Scientific Products Inc. Timeline (n) Purchase price Working capital Today 0 Year 1 Year 2 Year 3 Year 4 Year 5 $(400,000) ( 50,000) $ 50,000 $ 30,000 32,000 $ 62,000 x0.9091 Annual after-tax cash receipts Annual depreciation tax savings Total cash in (out) == PV factor (r 10%) Present value $(450,000) x 1.0000 $(450,000) + $ 56,364 + $ 56,195 $ 78,135 + $103,816 + $ 99,344 $ 36,000b $ 72,000 $120,000 78,000 32,000 $ 68,000 x0.8264 32,000 $104,000 x0.7513 32,000 $152,000 X0.6830 32,000 $160,000 x0.6209 = $(56,146) Since net present value is <0, reject the investment. (The investment provides a return less than 10%.) Net Present Value "Initial investment purchase price and working capital do not directly affect net income, and therefore are not adjusted for income taxes. "Amount equals net cash receipts before taxes x (1- tax rate). For year 1, $30,000 $50,000 x (10.40); for year 2, $36,000 $60,000 x (10.40); and so forth. Depreciation tax savings equals depreciation expense times the tax rate. Depreciation expense is $80,000 ($400,000 cost + 5 year useful life). Thus, annual depreciation tax savings is $32,000 (= $80,000 depreciation expense 0.40 tax rate).