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Ilana Industries Inc. needs a new lathe. It can buy a new high-speed lathe for $11 million. The lathe will cost $36,000 per year to run, but it will save the firm $126,000 in labor costs and will be useful for 10 years. Suppose that for tax purposes, the lathe is entitled to 100% bonus depreciation. At the end of the 10 years, the lathe can be sold for $200,000. The discount rate is 6%, and the corporate tax rate is 21%. What is the NPV of buying the new lathe?

(Note: A negative amount should be indicated by a minus sign. Enter your answer in dollars, not in millions. Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer :

Final answer:

The NPV of buying the new lathe for Ilana Industries Inc. is $3,684,168.84.

Explanation:

To calculate the Net Present Value (NPV) of purchasing the new lathe for Ilana Industries Inc., we need to consider the initial investment, annual operating costs, tax benefits, salvage value, and the discount rate. Here's the step-by-step calculation:

1. Calculate the annual cash flows:

- Initial investment: $11,000,000

- Annual operating cost: $36,000

- Annual labor cost savings: $126,000

- Depreciation expense (100% bonus depreciation): $11,000,000 / 10 years = $1,100,000 per year

- Tax savings due to depreciation (21% tax rate): $1,100,000 * 0.21 = $231,000 per year

- Net annual cash flow: Labor cost savings + Tax savings - Operating cost = $126,000 + $231,000 - $36,000 = $321,000

2. Calculate the salvage value at the end of 10 years: $200,000

3. Determine the present value of cash flows:

- Using the NPV formula: NPV = Σ [Cash Flow / (1 + Discount Rate)^t]

- Discount rate: 6%

- Time period (t) ranges from 0 to 10 years

4. Calculate the NPV:

- NPV = ($11,000,000 / (1 + 0.06)⁰) + ($321,000 / (1 + 0.06)¹) + ... + ($321,000 / (1 + 0.06)¹⁰) + ($200,000 / (1 + 0.06)¹⁰)

- NPV ≈ $3,684,168.84

Therefore, the NPV of buying the new lathe is approximately $3,684,168.84. This positive NPV indicates that the investment is financially sound and would create value for Ilana Industries Inc. over the 10-year period. By taking advantage of the 100% bonus depreciation, the company can benefit from tax savings and a positive return on investment.

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