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Ilana Industries Incorporated needs a new lathe. The company can buy a new high-speed lathe for $2.0 million. The lathe will cost $31,000 per year to operate, but it will save the firm $184,000 in labor costs annually and will be useful for 10 years. Assume that the lathe is entitled to 100% bonus depreciation for tax purposes. At the end of the 10 years, the lathe can be sold for $470,000. The discount rate is 10%, and the corporate tax rate is 21%. What is the NPV of buying the new lathe?

Answer :

Based on the given information and assumptions, it is not financially favorable for the company to buy the new lathe.

To calculate the net present value (NPV) of buying the new lathe, we need to determine the cash flows associated with the lathe over its useful life and discount them to present value using the given discount rate.

The cash flows involved in buying the new lathe can be categorized as follows:

Initial Investment:

Cost of the new lathe = -$2,000,000

Annual Cash Flows:

Savings in labor costs = $184,000

Operating costs = -$31,000

Terminal Cash Flow:

Resale value of the lathe = $470,000.

Now, let's calculate the NPV using the formula:

NPV = (Cash Flow / (1 + Discount Rate)^t) - Initial Investment

Where t represents the time period (year).

Using the provided information, we can calculate the NPV as follows:

NPV = (Savings in labor costs - Operating costs) / (1 + Discount Rate)^t + Resale value / (1 + Discount Rate)^10 - Initial Investment

NPV = ($184,000 - $31,000) / (1 + 0.10)^1 + $470,000 / (1 + 0.10)^10 - $2,000,000

NPV = $153,000 / (1.10) + $470,000 / (1.10)^10 - $2,000,00

NPV = $139,090 + $174,462 - $2,000,000

NPV = -$1,686,448

Since the NPV is negative, the buying decision would result in a net loss for Ilana Industries Incorporated.

For similar question on cash flows.

https://brainly.com/question/24179665

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