Question

Caradoc Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $418,000 is estimated to result in $158,000 in annual pre-tax cost savings. The press falls into Class 8 for CCA purposes (CCA rate of 20% per year), and it will have a salvage value at the end of the project of $55,800. The press also requires an initial investment in spare parts inventory of $28,000, along with an additional $3,900 in inventory for each succeeding year of the project. If the shop’s tax rate is 35% and its discount rate is 9%.

Calculate the NPV of this project. (Do not round your intermediate calculations. Round the final answer to 2 decimal places. .)

NPV           $ ________

Answer 1

Calculation of NPV of the project :

	Year 0	Year 1	Year 2	Year 3	Year 4
Initial Investment	418000
Annual Pre tax saving		158000	158000	158000	158000
Less : Depreciation (Working Note)		41800	75240	60192	48153.6
Earning before taxes		116200	82760	97808	109846.4
Taxes @ 35%		-40670	-28966	-34232.8	-38446.2
Earnings After Taxes		75530	53794	63575.2	71400.16
Add : Depreciation		41800	75240	60192	48153.6
Plus : Salvage Value					55800
Add : tax on salvage @ 35%					47885.04
NWC (Outflow subtracted in year 1 to 4 )	28000	3900	3900	3900	3900
Plus : Recapture of NWC					43600
Operating Cash Flows	446000	113430	125134	119867.2	262938.8
PV Factor @ 9%	1	0.917431	0.84168	0.772183	0.708425
PV of Net Cash flows (Inflow)		104064.2	105322.8	92559.47	186272.5
PV of Net Cash flows (Outflow)	446000
The net present value (NPV) of this project is		= $ 42218.951 or $ 42218.95
NPV = PV of cash inflow - PV of cash outflow
= 488218.951- 446000
= $ 42218.951 or $ 42218.95
Working Note :
Year 1 : 418000 * 10% = 41800
Year 2 : (418000-41800) * 20% = 75240
Year 3 : (418000-41800-75240) * 20% = 60192
Year 4 : (418000-41800-75240-60192) * 20% = 48153.6
Book Value = 418000-41800-75240-60192-48153.6=192614.4
Gain on Sale = Salvage Value - Book Value
= 55800 - 192614.4
= (-136814.4)
Tax on Loss on Sale = 136814.4*35%=47885.04

Yes, the company should buy and install as NPV is positive.

Note : As per CCA rule only half of the depreciation is allowed in 1 st year