Question

Massey Machine Shop is considering a four year project to improve its production efficiency.

Buying a new machine press for $730,000 is estimated to result in $220,000 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 $89,000. The press also requires an initial investment in spare parts

inventory of $26,000, along with an additional $3,000 in inventory for each succeeding year

of the project. At the end of the project, all the investment in the inventory will be recaptured.

The shop’s tax rate is 40 percent and its discount rate is 9 percent.

Answer 1

Tax rate		40%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4		Total
Cost		$       730,000	$      730,000	$       730,000	$       730,000
Dep Rate		20.00%	32.00%	19.20%	11.52%
Depreciation	Cost * Dep rate	$       146,000	$      233,600	$       140,160	$         84,096		$       603,856
Calculation of after-tax salvage value
Cost of machine			$      730,000
Depreciation			$      603,856
WDV	Cost less accumulated depreciation	$      126,144
Sale price			$        89,000
Profit/(Loss)	Sale price less WDV	$       (37,144)
Tax	Profit/(Loss)*tax rate	$       (14,858)
Sale price after-tax	Sale price less tax		$      103,858
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4
Annual cost saving		$       220,000	$      220,000	$       220,000	$       220,000
Less: Depreciation		$       146,000	$      233,600	$       140,160	$         84,096
Profit before tax (PBT)		$         74,000	$       (13,600)	$         79,840	$       135,904
Tax@40%	PBT*Tax rate	$         29,600	$         (5,440)	$         31,936	$         54,362
Profit After Tax (PAT)	PBT - Tax	$         44,400	$         (8,160)	$         47,904	$         81,542
Add Depreciation	PAT + Dep	$       146,000	$      233,600	$       140,160	$         84,096
Cash Profit after-tax		$       190,400	$      225,440	$       188,064	$       165,638
Calculation of NPV
						9.00%
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		$     (730,000)	$       (26,000)		$     (756,000)	1.0000	$     (756,000)
1			$         (3,000)	$       190,400	$       187,400	0.9174	$       171,927
2			$         (3,000)	$       225,440	$       222,440	0.8417	$       187,223
3			$         (3,000)	$       188,064	$       185,064	0.7722	$       142,903
4		$       103,858	$        35,000	$       165,638	$       304,496	0.7084	$       215,713
					Net Present Value	$       (38,234)