Question

1. Massey Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $450,000 is estimated to result in $150,000 in annual pretax cost savings. The press falls in the MACRS five year class, and it will have a salvage value at the end of the project of $90,000. The press also requires an initial investment in spare parts inventory of $18,000, along with an additional $3,000 in inventory for each succeeding year of the project. If the shop’s tax rate is 35% and its discount rate is 14%, should Massey buy and install the machine press?

please if you could use a financial calculator

Answer 1

Initial Investment = $450,000
Useful Life = 4 years

Depreciation Year 1 = 20.00% * $450,000
Depreciation Year 1 = $90,000

Depreciation Year 2 = 32.00% * $450,000
Depreciation Year 2 = $144,000

Depreciation Year 3 = 19.20% * $450,000
Depreciation Year 3 = $86,400

Depreciation Year 4 = 11.52% * $450,000
Depreciation Year 4 = $51,840

Book Value at the end of Year 4 = $450,000 - $90,000 - $144,000 - $86,400 - $51,840
Book Value at the end of Year 4 = $77,760

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $90,000 - ($90,000 - $77,760) * 0.35
After-tax Salvage Value = $85,716

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$450,000 - $18,000
Net Cash Flows = -$468,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $150,000 * (1 - 0.35) + 0.35 * $90,000
Operating Cash Flow = $129,000

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $129,000 - $3,000
Net Cash Flows = $126,000

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $150,000 * (1 - 0.35) + 0.35 * $144,000
Operating Cash Flow = $147,900

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $147,900 - $3,000
Net Cash Flows = $144,900

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $150,000 * (1 - 0.35) + 0.35 * $86,400
Operating Cash Flow = $127,740

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $127,740 - $3,000
Net Cash Flows = $124,740

Year 4:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $150,000 * (1 - 0.35) + 0.35 * $51,840
Operating Cash Flow = $115,644

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $115,644 + $27,000 + $85,716
Net Cash Flows = $228,360

Required Return = 14%

NPV = -$468,000 + $126,000/1.14 + $144,900/1.14^2 + $124,740/1.14^3 + $228,360/1.14^4
NPV = -$26,574.44

NPV of the machine press is negative; therefore, you should not purchase the machine press.