Paper Chase

T

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

Buy

-1050

-1850

Cost Saving

0

0

560

560

560

560

560

560

560

560

560

560

Net Income

-567

-999

302.40

302.40

302.40

302.40

302.40

302.40

302.40

302.40

302.40

302.40

Depreciation

-73

-73

706

486

483

483

242

0

0

0

0

Depreciation Saving

-33.58

-33.58

324.76

223.56

222.18

222.18

111.32

0.00

0.00

0.00

0.00

ITC

0

232

0

Residual

150

190

Net Residual

81

103

Cash Flow

-1723.58

-2492.58

1893.16

1571.96

1567.58

1567.58

1215.72

862.40

862.40

862.40

862.40

1155.00

Discount Rate

1.0000

0.8929

0.7972

0.7118

0.6355

0.5674

0.5066

0.4523

0.4039

0.3606

0.3220

0.2875

PV

-1723.58

-2225.518

1509.216

1118.890

996.225

889.487

615.922

390.106

348.309

310.990

277.670

332.035

NPV

-1391.545

According the above NPV calculation, the proposed equipment replacement generated a negative NPV for Paperco, which should guide the management to reject the equipment purchase plan based on the above assumptions.

NPV for equipment replacement under new tax legislation

The investment opportunity would generate a different NPV under the new tax legislation, which would be calculated on the basis of the following assumptions,

(1) Paperco's capital cost is 12%,

(2) the old equipment remain in service all of 1986,

(3) Paperco paid federal income taxes at the rate of 34%,

(4) Paperco's binding purchase contract is soon enough to earn a 8% ITC rate and the use of ACRS depreciation,

(5) physical life of new equipment after startup is 10 years,

(6) the ending point for our cash flow is December 1996.

Table 2 NPV for equipment replacement under new tax legislation ($ 000s)

T

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

Buy

-1050

-1850

Cost Saving

0

560

560

560

560

560

560

560

560

560

560

Net Income

-567

-1221

369.6

369.6

369.6

369.6

369.6

369.6

369.6...