Question

Geary Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $691,200 is estimated to result in $230,400 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 $100,800. The press also requires an initial investment in spare parts inventory of $28,800, along with an additional $4,320 in inventory for each succeeding year of the project.

Required :

If the shop's tax rate is 34 percent and its discount rate is 14 percent, what is the NPV for this project? (Do not round your intermediate calculations.)

Answer 1

Initial Investment = $691,200
Useful Life = 4 years

Depreciation Year 1 = 20.00% * $691,200
Depreciation Year 1 = $138,240

Depreciation Year 2 = 32.00% * $691,200
Depreciation Year 2 = $221,184

Depreciation Year 3 = 19.20% * $691,200
Depreciation Year 3 = $132,710.40

Depreciation Year 4 = 11.52% * $691,200
Depreciation Year 4 = $79,626.24

Book Value at the end of Year 4 = $691,200 - $138,240 - $221,184 - $132,710.40 - $79,626.24
Book Value at the end of Year 4 = $119,439.36

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $100,800 - ($100,800 - $119,439.36) * 0.34
After-tax Salvage Value = $107,137.38

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$691,200 - $28,800
Net Cash Flows = -$720,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $230,400 * (1 - 0.34) + 0.34 * $138,240
Operating Cash Flow = $199,065.60

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $199,065.60 - $4,320
Net Cash Flows = $194,745.60

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $230,400 * (1 - 0.34) + 0.34 * $221,184
Operating Cash Flow = $227,266.56

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $227,266.56 - $4,320
Net Cash Flows = $222,946.56

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $230,400 * (1 - 0.34) + 0.34 * $132,710.40
Operating Cash Flow = $197,185.54

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $197,185.54 - $4,320
Net Cash Flows = $192,865.54

Year 4:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $230,400 * (1 - 0.34) + 0.34 * $79,626.24
Operating Cash Flow = $179,136.92

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $179,136.92 + $41,760 + $107,137.38
Net Cash Flows = $328,034.30

Required Return = 14%

NPV = -$720,000 + $194,745.60/1.14 + $222,946.56/1.14^2 + $192,865.54/1.14^3 + $328,034.30/1.14^4
NPV = -$53,219.00