A company, whose earnings put it in the 25% marginal tax bracket, is considering the purchase of a new piece of equipment for $25,000. The equipment will be depreciated by using the straight-line method over a 4year depreciable life to a salvage value of $5000. It is estimated that the equipment will increase the company’s earnings by $8000 for each of the 4 years it is used. Should the equipment be purchased? Use an interest rate of 10%.

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Present Value

Present value (PV) is defined as the current or present value of all future sums of cash flow or money at a specified rate of return. This rate of return is known as the discounted rate, which is essentially the interest rate, discounted over some time. The expected cash flows are discounted at a discount rate to compute the present value. The higher the discount rate, the higher the future value (FV), but the lower the present value.