Thoma Pharmaceutical Company may buy DNA testing equipment costing $60 000. This equipment is

QUESTION

Thoma Pharmaceutical Company may buy DNA testing equipment costing $60,000. This equipment is expected to reduce labor costs of clinical staff by $20,000 annually. The equipment has a useful life of five years but falls in the three-year property class for cost recovery (depreciation) purposes. No salvage value is expected at the end. The corporate tax rate for Thoma is 38 percent (combined federal and state), and its required rate of return is 15 percent. (If profits after taxes on the project are negative in any year, the firm will offset the loss against other firm income for that year.) On the basis of this information, what is the net present value of the project? Is it acceptable?
This is acceptable as it has positive Net Present Value of $ 24,396. Year Cash flow Tax savings on depreciation Total Cash flow Discount factor @ 15% Discounted Amount 0 (60,000) (60,000) 1 (60,000) 1 20,000 7,600 27,600 0.870 24,000 2 20,000 7,600 27,600 0.756 20,870 3 20,000 7,600 27,600 0.658 18,147 4 20,000 20,000 0.572

1,435 5 20,000 20,000 0.497 9,944 Net Present Value 24,396 Depreciation = Cost / Life Depreciation = 60,000/3 years Depreciation = 20,000 Tax savings on depreciation = 38 % of 20,000 Tax savings on depreciation = 7,600

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