Question

CCC Shop is considering a project to improve their production efficiency. They are trying to decide whether it is a good idea or not to buy an automated injection molding machine which will result in reducing pre-tax costs by $500,000 for each of the next three years. The molding machine will cost $1,000,000 and the IRS says it must be depreciated as 3-year MACRS equipment. CCC Shop believes they can sell the machine for $80,000 at the end of three years. The molding machine will require an initial investment to increase inventory by $20,000, and then an additional inventory increase of $3,000 for each succeeding year of the project. CCC’s tax rate is 35% and uses a discount rate of 14%. CCC already spent $5000 investigating the feasibility of using the machine. Should CCC accept the project?

PLEASE SHOW ALL WORK!!!

DO NOT use table!!!!

DO NOT use a table!!!!!!!!!!!!

Show work step by step without a table!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

Answer 1

First, we will calculate the depreciation each year, which will be:
•D1 = $1,000,000(33.33%) = $333,300
•D2 = $1,000,000(44.45%) = $444,500
•D3 = $1,000,000(14.81%) = $148,100

•The book value of the equipment at the end of the project is:•BV4 = $1,000,000 – ($333,300 + 444,500 + 148,100) = $74,100

The asset is sold at a GAIN to book value, so this creates a tax Gain.
•After-tax salvage value = $80,000 - ($80,000 – 74,100)(0.35) = $76,165
•So, the OCF for each year will be:
•OCF1 = $500,000(1 – 0.35) + 0.35($333,300) = $441,655
•OCF2 = $500,000(1 – 0.35) + 0.35($444,500) = $480,575
•OCF3 = $500,000(1 – 0.35) + 0.35($148,100) = $376,835

$20,000 of NWC at the beginning, and $3,000 more in NWC each successive year.
We will subtract the $20,000 from the initial cash flow, and subtract $3,000 each year from the OCF to account for this spending.
During 3rd year the project required an additional $3,000, but we would get the money back immediately.So, the net cash flow for additional NWC would be zero

NPV = – $1,000,000 – 20,000 + ($441,655 – 3,000)/1.14 + ($480,575 – 3,000)/1.14^2 + ($376,835 + 26,000 + 76,165)/1.14^3

•NPV = +$55,575