Question

A proposed cost-saving device has an installed cost of $670,000. The device will be used in a five-year project but is classified as three-year MACRS property for tax purposes. The required initial net working capital investment is $49,000, the marginal tax rate is 30 percent, and the project discount rate is 8 percent. The device has an estimated Year 5 salvage value of $74,000. What level of pretax cost savings do we require for this project to be profitable? MACRS schedule (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Answer:

Calculation of Depreciation for each year:
D1 = $670,000 * 0.3333 = $223,311
D2 = $670,000 * 0.4445 = $297,815
D3 = $670,000 * 0.1481 = $99,227
D4 = $670,000 * 0.0741 = $49,647

Let Cost Saving be $C

Calculation of OCF of each year:
OCF1 = $C*(1-0.30) + 0.30 * $223,311 = $0.70*C + $66,993.30
OCF2 = $C*(1-0.30) + 0.30 * $297,815 = $0.70*C + $89,344.50
OCF3 = $C*(1-0.30) + 0.30 * $99,227 = $0.70*C + $29,768.10
OCF4 = $C*(1-0.30) + 0.30 * $49,647 = $0.70*C + $14,894.10
OCF5 = $C*(1-0.30) = $0.70*C

After Tax Salvage Value = $74,000 * (1 - 0.30)
After Tax Salvage Value = $51,800

NPV = -$670,000 - $49,000 + $0.70*C*PVIFA(8%, 5) + $66,993.30/1.08 + $89,344.50/1.08^2 + $29,768.10/1.08^3 + $14,894.10/1.08^4 + $51,800/1.08^5 + $49,000/1.08^5
0 = -$670,000 - $49,000 + $0.70*C*PVIFA(8%, 5) + $66,993.30/1.08 + $89,344.50/1.08^2 + $29,768.10/1.08^3 + $14,894.10/1.08^4 + $51,800/1.08^5 + $49,000/1.08^5
0 = -$719,000 + $0.70*C*3.9927 + $241,810.61
$C*2.79489 = $477,189.39
$C = $170,736.37

So, company needs a pretax cost saving of $170,736.37 to operate this project profitably.