Question

Massey Machine Shop is considering a four-year project to improve its production efficiency. Six months ago, it contracted with Dr. Wright to provide a thorough study of whether there was a need for this four-year efficiency project. The report was delivered one month ago and it’s cost was $30,000. The report suggests that the company should go ahead with the project subject to Massey’s financial analysis. Buying a new machine press for $450,000 is estimated to result in $120,000 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 $85,000. At time 0, the press will also require an additional investment in inventory of $9,000. Meanwhile, the accounts payable will increase by $3000. Every other current accounts remain the same. If the company’s tax rate is 20% and the discount rate is 12%, should the company accept the project?   (30 pts). The MACRS schedule is as follows:

           

Year	5-year Class
1	20%
2	32%
3	19.2%
4	11.52%
5	11.52%
6	5.76%

Answer 1

	Year 0	Year 1	Year 2	Year 3	Year 4
Initial Investment	-450000
Before tax Operating Cost saving		120000	120000	120000	120000
Less : Depreciation (Working Note)		90000	144000	86400	51840
Earning before taxes		30000	-24000	33600	68160
Taxes @ 20%		6000	-4800	6720	13632
Net Income		24000	-19200	26880	54528
Add : Depreciation		90000	144000	86400	51840
Add: Salvage Value					85000
Less : Tax on Sale					1448
Net Working Capital (9000 - 3000)	-6000
Recapture of Net Working Capital					6000
Free Cash Flows	-456000	114000	124800	113280	195920
PV Factor @ 12%	1	0.892857	0.797194	0.71178	0.635518
PV of Net Cash flows (Inflow)		101785.7	99489.8	80630.47	124510.7
PV of Net Cash flows (Outflow)	-456000
The net present value (NPV) of this project is		=   $ -49583.3214
NPV = PV of cash inflow - PV of cash outflow
= 406416.6786- 456000
=   $ -49583.3214
Working Note :
Year 1 : 450000 * 20% = 90000
Year 2 : 450000 * 32% = 144000
Year 3 : 450000 * 19.2% = 86400
Year 4 : 450000 * 11.52% = 51840
Book Value = 0
Gain on Sale = Salvage Value - Book Value
= 85000- 77760
= 7240 Tax on Gain on Sale = 7240 * 20% = 1448

No as the NPV is negative.