Chapter 21, Problem 21.41P

NPV, inflation and taxes. Fancy Foods is considering replacing all 12 of its meat scales with new, digital ones. The old scales are fully depreciated and have no disposal value. The new scales cost $120,000 (in total). Because the new scales are more efficient and more accurate than the old scales, Fancy Foods will have annual incremental cash savings from using the new scales in the amount of $30,000 per year. The scales have a 6-year useful life and no terminal disposal value and are depreciated using the straight-line method. Fancy Foods requires a 6% real rate of return.

1. 1. Given the preceding information, what is the net present value of the new scales? Ignore taxes.

   Required

2. 2. Assume the $30,000 cost savings are in current real dollars and the inflation rate is 4%. Recalculate the NPV of the project.
3. 3. Based on your answers to requirements 1 and 2, should Fancy Foods buy the new meat scales?
4. 4. Now assume that the company’s tax rate is 25%. Calculate the NPV of the project assuming no inflation.
5. 5. Again assuming that the company faces a 25% tax rate, calculate the NPV of the project under an inflation rate of 4%.
6. 6. Based on your answers to requirements 4 and 5, should Fancy Foods buy the new meat scales?