Question

Starset Machine Shop is considering a 4-year project to improve its production efficiency. Buying a new machine press for $465,000 is estimated to result in $193,000 in annual pretax cost savings. The press falls in the 5-year MACRS class, and it will have a salvage value at the end of the project of $73,000. The press also requires an initial investment in spare parts inventory of $36,000, along with an additional $3,900 in inventory for each succeeding year of the project. The shop’s tax rate is 21 percent and its discount rate is 12 percent. (MACRS schedule)

Calculate the NPV of this project.

Answer 1

Assuming that the working capital is recovered at the end of the project in year 4.

NPV	$93,268.09

Workings

Operating cash flows

OCF		MACRS 5 year
Year	Cash flows	Depreciation	EBIT	Tax	PAT	OCF
1	193000	93000	100000	21000	79000	172000
2	193000	148800	44200	9282	34918	183718
3	193000	89280	103720	21781.2	81938.8	171218.8
4	193000	53568	139432	29280.72	110151.28	163719.28

Salvage of the machine

Salvage
Purchase price	465000
Less: Depreciation	384648
Closing book value	80352
Selling price	73000
Gain/(loss)	-7352
Tax/ Saving	1543.92
Net salvage	74543.92

Net Cash flows

Year	Initial cash flow	OCF	Working capital	Salvage	Net cash flows
0	-465000		-36000		-501000
1		$172,000.00	-3900		168100
2		$183,718.00	-3900		179818
3		$171,218.80	-3900		167318.8
4		$163,719.28	47700	74543.92	285963.2

Formulae