Question

Masters Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $624,000 is estimated to result in $208,000 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 $91,000. The press also requires an initial investment in spare parts inventory of $26,000, along with an additional $3,900 in inventory for each succeeding year of the project. If the shop's tax rate is 22 percent and its discount rate is 11 percent, what is the NPV for this project?

Answer 1

Initial Investment = $624,000
Useful Life = 4 years

Depreciation Year 1 = 20.00% * $624,000
Depreciation Year 1 = $124,800

Depreciation Year 2 = 32.00% * $624,000
Depreciation Year 2 = $199,680

Depreciation Year 3 = 19.20% * $624,000
Depreciation Year 3 = $119,808

Depreciation Year 4 = 11.52% * $624,000
Depreciation Year 4 = $71,884.80

Book Value at the end of Year 4 = $624,000 - $124,800 - $199,680 - $119,808 - $71,884.80
Book Value at the end of Year 4 = $107,827.20

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $91,000 - ($91,000 - $107,827.20) * 0.22
After-tax Salvage Value = $94,701.984

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$624,000 - $26,000
Net Cash Flows = -$650,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $208,000 * (1 - 0.22) + 0.22 * $124,800
Operating Cash Flow = $189,696

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $189,696 - $3,900
Net Cash Flows = $185,796

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $208,000 * (1 - 0.22) + 0.22 * $199,680
Operating Cash Flow = $206,169.60

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $206,169.60 - $3,900
Net Cash Flows = $202,269.60

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $208,000 * (1 - 0.22) + 0.22 * $119,808
Operating Cash Flow = $188,597.76

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $188,597.76 - $3,900
Net Cash Flows = $184,697.76

Year 4:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $208,000 * (1 - 0.22) + 0.22 * $71,884.80
Operating Cash Flow = $178,054.656

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $178,054.656 + $37,700 + $94,701.984
Net Cash Flows = $310,456.64

Required Return = 11%

NPV = -$650,000 + $185,796/1.11 + $202,269.60/1.11^2 + $184,697.76/1.11^3 + $310,456.64/1.11^3
NPV = $21,107.14

NPV of this project is $21,107.14 or $21,107