Question

Yasmin Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $777,600 is estimated to result in $259,200 in annual pretax cost savings. The press falls in the MACRS five-year class (MACRS Table), and it will have a salvage value at the end of the project of $113,400. The press also requires an initial investment in spare parts inventory of $32,400, along with an additional $4,860 in inventory for each succeeding year of the project. If the shop's tax rate is 33 percent and its discount rate is 16 percent, the NPV for the project is $____ and the company (Choose one: should or should not) buy and install the machine press.

(Round your answer to two decimal places)

Answer 1

Initial Investment = $777,600
Useful Life = 4 years

Depreciation Year 1 = 20.00% * $777,600
Depreciation Year 1 = $155,520

Depreciation Year 2 = 32.00% * $777,600
Depreciation Year 2 = $248,832

Depreciation Year 3 = 19.20% * $777,600
Depreciation Year 3 = $149,299.20

Depreciation Year 3 = 11.52% * $777,600
Depreciation Year 3 = $89,579.52

Book Value at the end of Year 4 = $777,600 - $155,520 - $248,832 - $149,299.20 - $89,579.52
Book Value at the end of Year 4 = $134,369.28

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $113,400 - ($113,400 - $134,369.28) * 0.33
After-tax Salvage Value = $120,319.86

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$777,600 - $32,400
Net Cash Flows = -$810,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $259,200 * (1 - 0.33) + 0.33 * $155,520
Operating Cash Flow = $224,985.60

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $224,985.60 - $4,860
Net Cash Flows = $220,125.60

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $259,200 * (1 - 0.33) + 0.33 * $248,832
Operating Cash Flow = $255,778.56

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $255,778.56 - $4,860
Net Cash Flows = $250,918.56

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $259,200 * (1 - 0.33) + 0.33 * $149,299.20
Operating Cash Flow = $222,932.74

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $222,932.74 - $4,860
Net Cash Flows = $218,072.74

Year 4:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $259,200 * (1 - 0.33) + 0.33 * $89,579.52
Operating Cash Flow = $203,225.24

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $203,225.24 + $46,980 + $120,319.86
Net Cash Flows = $370,525.10

Required Return = 16%

NPV = -$810,000 + $220,125.60/1.16 + $250,918.56/1.16^2 + $218,072.74/1.16^3 + $370,525.10/1.16^4
NPV = -$89,415.50

The NPV for the project is -$89,415.50 and the company should not buy and install the machine press