Question

You must evaluate a proposal to buy a new milling machine with purchase price of $150,000. The machine will be depreciated to zero value over the 4 years using prime cost (straight line) method. The machine would be sold after 4 years for $70,000. Inventory will increase by $17,000 and account payables will rise by $7,500. All other working capital components will stay the same, so the change in net working capital is $9,500. The managers expect to fully recover the working capital of $9,500 at the end of the project (year 4).

The pretax labor costs would decline by $50,000 per year.

Below shows the forecasted sales revenues, variable cost and fixed cost.

	Year 1	Year 2	Year 3	Year 4
Sales quantity (units)	2,500	3,000	3,500	4,000
Selling price per unit	$3	$3.1	$3.2	$3.3
Fixed cost of production (per year)	$2,000	$2,100	$2,200	$2,300
Variable cost of production (per unit)	$1.1	$1.2	$1.25	$1.35

The marginal tax rate is 35% and the discount rate is 10.5%.

Question： What is the net present value (NPV) of the proposal?

Answer 1

Year	0	1	2	3	4
1.Purchase price	-150000
2.NWC reqd.& recovered(-17000+7500)	-9500				9500
3. After-tax sale value of the m/c(70000*(1-35%))					45500
Operating cash flows:
4.Sales quantity (units)		2,500	3,000	3,500	4,000
5.Selling price per unit		3	3.1	3.2	3.3
6.Total Sales $ (4*5)		7500	9300	11200	13200
7.Fixed cost of production (per year)		-2000	-2100	-2200	-2300
8.Variable cost of production (per unit)		1.1	1.2	1.25	1.35
9.Total variable costs(4*8)		-2750	-3600	-4375	-5400
10.Savings in Pretax labor costs		50000	50000	50000	50000
11. Depn.(150000/4)		-37500	-37500	-37500	-37500
12. EBT(6+7+9+10+11)		15250	16100	17125	18000
13.Tax at 35%(12*35%)		-5338	-5635	-5994	-6300
14.EAT/NOPAT(12+13)		9913	10465	11131	11700
15. Add back: depn.(row 11)		37500	37500	37500	37500
16.Operating cash flows		47413	47965	48631	49200
17.Total annual FCFs(1+2+3+16)	-159500	47412.5	47965	48631.25	104200
18.PV F at 10.5%(1/1.10%^ yr.n)	1	0.90498	0.81898	0.74116	0.67073
19.PV at 10.5%(17*18)	-159500	42907.24	39282.57	36043.64	69890.57
20.NPV at 10.5%(sum of row 19)	28624.02
	(Answer)
The proposal is recommended as the NPV of its cashflows is POSITIVE.