Question

Problem 8-11 Cost-Cutting Proposals

Blue Line Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $560,000 is estimated to result in $235,000 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 $94,000. The press also requires an initial investment in spare parts inventory of $29,000, along with an additional $3,400 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and the project's required return is 9 percent. Refer to Table 8.3.

Calculate the NPV of this project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
  
NPV           $

Should the company buy and install the machine press?
  

• No

• Yes

Answer 1

Time line		0	1	2	3	4
Cost of new machine		-560000
Initial working capital		-29000
=Initial Investment outlay		-589000
5 years MACR rate			20.00%	32.00%	19.20%	11.52%	17.28%
Savings			235000	235000	235000	235000
-Depreciation	=Cost of machine*MACR%		-112000	-179200	-107520	-64512	96768	=Salvage Value
-working capital to be maintained			-3400	-3400	-3400	-3400
=Pretax cash flows			119600	52400	124080	167088
-taxes	=(Pretax cash flows)*(1-tax)		77740	34060	80652	108607.2
+Depreciation			112000	179200	107520	64512
=after tax operating cash flow			189740	213260	188172	173119.2
reversal of working capital						42600
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)					61100
+Tax shield on salvage book value	=Salvage value * tax rate					33868.8
=Terminal year after tax cash flows						137568.80
Total Cash flow for the period		-589000	189740	213260	188172	310688
Discount factor=	(1+discount rate)^corresponding period	1	1.09	1.1881	1.295029	1.41158161
Discounted CF=	Cashflow/discount factor	-589000	174073.3945	179496.6754	145303.3098	220099.212
NPV=	Sum of discounted CF=	129972.59

Accept project as NPV is positive