Question

Geary Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $720,000 is estimated to result in $240,000 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 $105,000. The press also requires an initial investment in spare parts inventory of $30,000, along with an additional $4,500 in inventory for each succeeding year of the project. Required : If the shop's tax rate is 35 percent and its discount rate is 16 percent, what is the NPV for this project? (Do not round your intermediate calculations.) rev: 09_18_2012 $-106,139.92 $-103,318.84 $-170,365.41 $-111,446.91 $-100,832.92

Answer 1

Initial Investment = $720,000
Useful Life = 4 years

Depreciation Year 1 = 20.00% * $720,000
Depreciation Year 1 = $144,000

Depreciation Year 2 = 32.00% * $720,000
Depreciation Year 2 = $230,400

Depreciation Year 3 = 19.20% * $720,000
Depreciation Year 3 = $138,240

Depreciation Year 4 = 11.52% * $720,000
Depreciation Year 4 = $82,944

Book Value at the end of Year 4 = $720,000 - $144,000 - $230,400 - $138,240 - $82,944
Book Value at the end of Year 4 = $124,416

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $105,000 - ($105,000 - $124,416) * 0.35
After-tax Salvage Value = $111,795.60

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$720,000 - $30,000
Net Cash Flows = -$750,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $240,000 * (1 - 0.35) + 0.35 * $144,000
Operating Cash Flow = $206,400

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $206,400 - $4,500
Net Cash Flows = $201,900

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $240,000 * (1 - 0.35) + 0.35 * $230,400
Operating Cash Flow = $236,640

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $236,640 - $4,500
Net Cash Flows = $232,140

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $240,000 * (1 - 0.35) + 0.35 * $138,240
Operating Cash Flow = $204,384

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $204,384 - $4,500
Net Cash Flows = $199,884

Year 4:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $240,000 * (1 - 0.35) + 0.35 * $82,944
Operating Cash Flow = $185,030.40

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $185,030.40 + $43,500 + $111,795.60
Net Cash Flows = $340,326

Required Return = 16%

NPV = -$750,000 + $201,900/1.16 + $232,140/1.16^2 + $199,884/1.16^3 + $340,326/1.16^4
NPV = -$87,414.20