Question

Starset Machine Shop is considering a 4-year project to improve its production efficiency. Buying a new machine press for $440,000 is estimated to result in $178,000 in annual pretax cost savings. The press falls in the 5-year MACRS class, and it will have a salvage value at the end of the project of $72,000. The press also requires an initial investment in spare parts inventory of $31,000, along with an additional $3,650 in inventory for each succeeding year of the project. The shop’s tax rate is 21 percent and its discount rate is 12 percent. (MACRS schedule) Calculate the NPV of this project.

(Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Initial Investment = $440,000
Useful Life = 4 years

Depreciation Year 1 = 20.00% * $440,000
Depreciation Year 1 = $88,000

Depreciation Year 2 = 32.00% * $440,000
Depreciation Year 2 = $140,800

Depreciation Year 3 = 19.20% * $440,000
Depreciation Year 3 = $84,480

Depreciation Year 4 = 11.52% * $440,000
Depreciation Year 4 = $50,688

Book Value at the end of Year 4 = $440,000 - $88,000 - $140,800 - $84,480 - $50,688
Book Value at the end of Year 4 = $76,032

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $72,000 - ($72,000 - $76,032) * 0.21
After-tax Salvage Value = $72,846.72

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$440,000 - $31,000
Net Cash Flows = -$471,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $178,000 * (1 - 0.21) + 0.21 * $88,000
Operating Cash Flow = $159,100

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $159,100 - $3,650
Net Cash Flows = $155,450

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $178,000 * (1 - 0.21) + 0.21 * $140,800
Operating Cash Flow = $170,188

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $170,188 - $3,650
Net Cash Flows = $166,538

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $178,000 * (1 - 0.21) + 0.21 * $84,480
Operating Cash Flow = $158,360.80

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $158,360.80 - $3,650
Net Cash Flows = $154,710.80

Year 4:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $178,000 * (1 - 0.21) + 0.21 * $50,688
Operating Cash Flow = $151,264.48

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $151,264.48 + $41,950 + $72,846.72
Net Cash Flows = $266,061.20

Required Return = 12%

NPV = -$471,000 + $155,450/1.12 + $166,538/1.12^2 + $154,710.80/1.12^3 + $266,061.20/1.12^4
NPV = $79,764.51

So, NPV of the project is $79,764.51