Question

Pooh Industries is contemplating purchasing a new machine that will significantly improve the efficiency of their operations. To date the company has spent $15,000 evaluating the machine to better determine annual operating savings from using the machine. The new machine would cost $800,000 and would be depreciated over an expected life of 8 years to a $40,000 salvage value using the straight-line method. Pooh forecasts that the new machine would reduce operating expenses by $200,000 per year. The firm's marginal tax rate is 40% and its WACC (which is the appropriate rate to use for evaluating this machine) is 15%. Pooh estimates that the new machine could be sold at the end of its life (i.e., in 8 years) for salvage value (i.e., $40,000). The new machine would require additional net working capital of $90,000 which will be recovered at the end of the project. The company will hire a new mechanic for maintenance of the machine as well as for other duties related to this project. This new employee will cost the company $75,000 per year (this amount is not included in the operating cost change listed above). What is this project’s NPV?

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -

Please note machine evaluation cost i.e $15,000 is not considered because it is a sunk cost.

Hope this will help, please do comment if you need any further explanation. Your feedback would be appreciated.