Question

Starset Machine Shop is considering a 4-year project to improve its production efficiency. Buying a new machine press for $405,000 is estimated to result in $157,000 in annual pretax cost savings. The press qualifies for 100 percent bonus depreciation, and it will have a salvage value at the end of the project of $57,000. The press also requires an initial investment in spare parts inventory of $24,000, along with an additional $3,300 in inventory for each succeeding year of the project. The shop’s tax rate is 24 percent and its discount rate is 11 percent.

Calculate the NPV of this project.

Answer 1

Calculation of NPV of project
Year	0	1	2	3	4	NPV
Investment in new machine press	-$405,000.00
Investment in spare parts inventory	-$24,000.00	-$3,300.00	-$3,300.00	-$3,300.00
Pretax cost savings		$157,000.00	$157,000.00	$157,000.00	$157,000.00
Tax @ 24% on cost savings		-$37,680.00	-$37,680.00	-$37,680.00	-$37,680.00
Depreciation tax shield		$97,200.00
Salvage value					$57,000.00
Tax @ 24% on salvage value					-$13,680.00
Net Cash flow	-$429,000.00	$213,220.00	$116,020.00	$116,020.00	$162,640.00
x Discount factor @ 11%	1	0.9009009	0.81162243	0.73119138	0.65873097
Present Value	-$429,000.00	$192,090.09	$94,164.43	$84,832.82	$107,136.01	$49,223.35
NPV of the project =	$49,223.35
Working
Depreciation tax shield for Year 1 = Depreciation expense for year 1 x Tax rate = $405000 x 24% = $97,200