Question

Problem 8-31 Calculating Required Savings

A proposed cost-saving device has an installed cost of $630,000. The device will be used in a five-year project but is classified as three-year MACRS property for tax purposes. The required initial net working capital investment is $45,000, the marginal tax rate is 34 percent, and the project discount rate is 10 percent. The device has an estimated Year 5 salvage value of $70,000. What level of pretax cost savings do we require for this project to be profitable? Refer to Table 8.3. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
  
Pretax cost savings           $

Answer 1

Solution:-

First we need to calculate Depreciation of each year-

Depreciation of year 1 = $6,30,000 * 0.3333 = $2,09,979

Depreciation of year 2 = $6,30,000 * 0.4445 = $2,80,035

Depreciation of year 3 = $6,30,000 * 0.1481 = $93,303

Depreciation of year 4 = $6,30,000 * 0.0741 = $46,683

After Tax Salvage Value = $70,000 (1-0.34) = $46,200

By Using the Tax Sheild Approach, The Operating cash flow of each year-

OCF1 = (Sales-Cost) * (1-0.34) + 0.34 ($2,09,979)

OCF2 = (Sales-Cost) * (1-0.34) + 0.34 ($2,80,035)

OCF3 = (Sales-Cost) * (1-0.34) + 0.34 ($93,303)

OCF4 = (Sales-Cost) * (1-0.34) + 0.34 ($46,200)

OCF5 = (Sales-Cost) * (1-0.34)

To Calculate Sales-Cost we need to Zero NPV, then Equation will be-

NPV = Present Value of Cash Inflow - Present Value of cash outflow

0 =

Pretax cost savings do we require for this project to be profitable is amounting to $1,90,846.06

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