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.)

Should the company buy and install the machine press? No Yes

Answer 1

book value of press at end of 4 years = 440,000 - accumulated depreciation = 440,000 - 363,968 = 76,032

salvage value = 72,000

loss on sale of press = 72,000 - 76,032 = 4,032

after-tax salvage value = 72,000 + (4,032 * 21%) = 72,847

OCF in each year = income after tax + depreciation

Project Cash flow in year 0 = initial investment + spare parts investment

Project Cash flow in years 1 to 3 = OCF + additional spare parts investment

Project Cash flow in year 4 = OCF + terminal cash flow

NPV is calculated to be $79,764.51