Question

Masters Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $988,800 is estimated to result in $329,600 in annual pretax cost savings. The press falls in the MACRS five-year class (MACRS Table), and it will have a salvage value at the end of the project of $144,200. The press also requires an initial investment in spare parts inventory of $41,200, along with an additional $6,180 in inventory for each succeeding year of the project.

If the shop's tax rate is 24 percent and its discount rate is 11 percent, what is the NPV for this project?

Multiple Choice

$26,323.17

$29,212.46

$-85,094.26

$27,639.33

$25,007.02

Answer 1

Answer is $26,323.17

Initial Investment = $988,800
Useful Life = 4 years

Depreciation Year 1 = 20.00% * $988,800
Depreciation Year 1 = $197,760

Depreciation Year 2 = 32.00% * $988,800
Depreciation Year 2 = $316,416

Depreciation Year 3 = 19.20% * $988,800
Depreciation Year 3 = $189,849.60

Depreciation Year 3 = 11.52% * $988,800
Depreciation Year 3 = $113,909.76

Book Value at the end of Year 4 = $988,800 - $197,760 - $316,416 - $189,849.60 - $113,909.76
Book Value at the end of Year 4 = $170,864.64

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $144,200 - ($144,200 - $170,864.64) * 0.24
After-tax Salvage Value = $150,599.51

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$988,800 - $41,200
Net Cash Flows = -$1,030,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $329,600 * (1 - 0.24) + 0.24 * $197,760
Operating Cash Flow = $297,958.40

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $297,958.40 - $6,180
Net Cash Flows = $291,778.40

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $329,600 * (1 - 0.24) + 0.24 * $316,416
Operating Cash Flow = $326,435.84

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $326,435.84 - $6,180
Net Cash Flows = $320,255.84

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $329,600 * (1 - 0.24) + 0.24 * $189,849.60
Operating Cash Flow = $296,059.90

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $296,059.90 - $6,180
Net Cash Flows = $289,879.90

Year 4:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $329,600 * (1 - 0.24) + 0.24 * $113,909.76
Operating Cash Flow = $277,834.34

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $277,834.34 + $59,740 + $150,599.51
Net Cash Flows = $488,173.85

Required Return = 11%

NPV = -$1,030,000 + $291,778.40/1.11 + $320,255.84/1.11^2 + $289,879.90/1.11^3 + $488,173.85/1.11^4
NPV = $26,323.17

So, NPV of the project is $26,323.17