Sapna Patel is manager of the customer-service division of an electrical appliance store. Sapna is considering buying a repairing machine that costs $12,000 on December 31, 2012. The machine will last five years. Sapna estimates that the incremental pretax cash savings from using the machine will be $3,600 annually. The $3,600 is measured at current prices and will be received at the end of each year. For tax purposes, the machinery qualifies for a capital cost allowance rate of 25%, declining balance. Sapna requires a 10% after-tax real rate of return (that is, the rate of return is 10% when all cash flows are denominated in December 31, 2012, dollars). Use the 10% after-tax real rate of return when answering all four requirements.
REQUIRED
Treat each of the following cases independently.
1. Sapna lives in a world without income taxes and without inflation. What is the net present value of the machine in this world?
2. Sapna lives in a world without inflation, but there is an income tax rate of 40%. What is the net present value of the machine in this world?
3. There are no income taxes, but the annual inflation rate is 20%. What is the net present value of the machine? The cash savings each year will be increased by a factor equal to the cumulative inflation rate.
4. The annual inflation rate is 20%, and the income tax rate is 40%. What is the net present value of the machine?