Question

XYZ company is considering a new machine that costs $300,000 and would reduce pre-tax manufacturing costs by $108,000 annually. XYZ would use the 3-year MACRS method to depreciate the machine, and management thinks the machine would have a value of $23,000 at the end of its 5-year operating life. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The net operating working capital (NOWC) would increase by $25,000 initially, but it would be recovered at the end of the project's 5-year life. XYZ’s marginal tax rate is 40-percent, and a 10% WACC is appropriate for the project. a) Calculate the projects NPV, IRR, and Payback. b) Assume management is unsure about the $90,000 cost savings, and this figure could deviate by as much as +/- 15%. What would the NPV have to be under each of these situations?

Answer 1

	Initial Cash Flow
	Cost of Machine	$300,000
	Net working capital	$25,000.00
	Total	$325,000.00
		OPERATING CASH FLOW
			A	B=0.4*A	C=A-B
			Before tax	Tax	After Tax
		Year	Savings	Expense (40%)	Profit
		1	$108,000	$43,200	$64,800
		2	$108,000	$43,200	$64,800
		3	$108,000	$43,200	$64,800
		4	$108,000	$43,200	$64,800
		5	$108,000	$43,200	$64,800
		DEPRECIATION TAX SHIELD
			A	B=A*$300,000	C=B*0.4
			Depreciation	Amount of	Depreciation
		Year	Rate	Depreciation	Tax shield
		1	33.00%	$99,000	$39,600
		2	45.00%	$135,000	$54,000
		3	15.00%	$45,000	$18,000
		4	7.00%	$21,000	$8,400
		5	0%	$0	$0
	TERMINAL CASH FLOW
A	Salvage value of Machine	$23,000
B=A*0.4	Tax on gain on salvage	$9,200
C=A-B	After tax salvage cash flow	$13,800			A	B	C	D	E	F=B+C+D+E	G=E/(1.1^A)
D	Release of working capital	$25,000				initial cash	Operating	Depreciation	Terminal	Net	Present value	Cumulative
E=C+D	TotalTerminal Cash Flow	$38,800			Year	flow	cashflow	Tax shield	Cashflow	Cash flow	ofNet cashflow	Net Cash flow
					0	($325,000)				($325,000)	($325,000)	($325,000)
	Present Value (PV) of Cash Flow:				1		$64,800	$39,600		$104,400	$94,909	($220,600)
	(Cash Flow)/((1+i)^N)				2		$64,800	$54,000		$118,800	$98,182	($101,800)
	i=Discount Rate=WACC=10%=0.1				3		$64,800	$18,000		$82,800	$62,209	($19,000)
	N=Year of Cash Flow				4		$64,800	$8,400		$73,200	$49,997	$54,200
					5		$64,800	$0	$38,800	$103,600	$64,327	$157,800
										Total	$44,624
	NPV of the Project	$44,623.81
	IRR of the project	15.46%	(Using IRR function of excel over Net Cash flow)
	Pay BackPeriod=(3+(19000/73200))	3.26	Years	(Year at which Cumulative net cash flow=0)
	IF THE ANNUAL SAVINGS IS -15%(Note There is error in the question. Instead of $90,000base case savings , it should be $108,000