The net present value of the project is $16,530, calculated as follows: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Initial cost $(500,000) After-tax cash flow (pre-tax CF × .6) $ 30,000 $ 30,000 $240,000 $240,000 $240,000 Depreciation tax shield ($500,000 ÷ 5 × .4) 40,000 40,000 40,000 40,000 40,000 Net after-tax cash flow (500,000) 70,000 70,000 280,000 280,000 280,000 PV of $1 Discount factor-20% 1.000 .833 .694 .579 .482 .402 Discounted cash flow $(500,000) $ 58,310 $48,580 $ 162,120 $134,960 $112,560 Cumulative cash flow $(500,000) $(441,690) $(393,110) $(230,990) $(96,030) $16,530
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This answer results from omitting the depreciation tax shield as a cash inflow in each of the five years of the project.
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The machine will be depreciated over 5 years on a straight-line basis for tax purposes and Lunar is subject to a 40% effective income tax rate. Assuming Lunar will have significant taxable income from other lines of business, and using a 20% discount rate, the net present value of the project would be