Question

Geary Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $566,400 is estimated to result in $188,800 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 $82,600. The press also requires an initial investment in spare parts inventory of $23,600, along with an additional $3,540 in inventory for each succeeding year of the project. Required : If the shop's tax rate is 31 percent and its discount rate is 20 percent, what is the NPV for this project?

Answer 1

Initial Investment = $566,400

Depreciation Expense for Year 1 = $566,400 * 20.00%
Depreciation Expense for Year 1 = $113,280.00

Depreciation Expense for Year 2 = $566,400 * 32.00%
Depreciation Expense for Year 2 = $181,248.00

Depreciation Expense for Year 3 = $566,400 * 19.20%
Depreciation Expense for Year 3 = $108,748.80

Depreciation Expense for Year 4 = $566,400 * 11.52%
Depreciation Expense for Year 4 = $65,249.28

Book Value at the end of Year 4 = $566,400 - $113,280 - $181,248 - $108,748.80 - $65,249.28
Book Value at the end of Year 4 = $97,873.92

Salvage Value = $82,600

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax
After-tax Salvage Value = $82,600 - ($82,600 - $97,873.92) * 0.31
After-tax Salvage Value = $87,334.92

Investment in NWC:
Year 0 = $23,600
Year 1 = $3,540
Year 2 = $3,540
Year 3 = $3,540
NWC recovered in Year 4 = $34,220

OCF Year 1 = Pretax Cost Saving * (1 - tax) + tax * Depreciation
OCF Year 1 = $188,800 * (1 - 0.31) + 0.31 * $113,280
OCF Year 1 = $165,388.80

OCF Year 2 = Pretax Cost Saving * (1 - tax) + tax * Depreciation
OCF Year 2 = $188,800 * (1 - 0.31) + 0.31 * $181,248
OCF Year 2 = $186,458.88

OCF Year 3 = Pretax Cost Saving * (1 - tax) + tax * Depreciation
OCF Year 3 = $188,800 * (1 - 0.31) + 0.31 * $108,748.80
OCF Year 3 = $163,984.13

OCF Year 4 = Pretax Cost Saving * (1 - tax) + tax * Depreciation
OCF Year 4 = $188,800 * (1 - 0.31) + 0.31 * $65,249.28
OCF Year 4 = $150,499.28

NPV = -$566,400 - $23,600 + $165,388.80/1.20 - $3,540/1.20 + $186,458.88/1.20^2 - $3,540/1.20^2 + $163,984.13/1.20^3 - $3,540/1.20^3 + $150,499.28/1.20^4 + $34,220/1.20^4 + $87,334.92/1.20^4
NPV = -$104,050.41

So, NPV for this project is -$104,050.41