Question

Chapman Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $620,000 is estimated to result in $211,000 in annual pretax cost savings. The press falls in the MACRS 3-year class, and it will have a salvage value at the end of the project of $98,000. The MACRS rates are 0.33, 0.45, 0.15, and 0.07 for Years 1 to 4, respectively. The press also requires an initial investment in spare parts inventory of $24,000, along with an additional $3,600 in inventory for each succeeding year of the project. The inventory will return to its original level when the project ends. The shop's tax rate is 35 percent and its discount rate is 11 percent. Should the firm buy and install the machine press? Why or why not? Show your work!!!

Answer 1

Time line		0	1	2	3	4
Cost of new machine		-620000
Initial working capital		-24000
=Initial Investment outlay		-644000
Savings			211000	211000	211000	211000
-Depreciation	Cost of equipment/no. of years		-204600	-279000	-93000	-43400
-working capital to be maintained			-3600	-3600	-3600	-3600
=Pretax cash flows			2800	-71600	114400	164000
-taxes	=(Pretax cash flows)*(1-tax)		1820	-46540	74360	106600
+Depreciation			204600	279000	93000	43400
=after tax operating cash flow			206420	232460	167360	150000
reversal of working capital						38400
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)					63700
+Tax shield on salvage book value	=Salvage value * tax rate					0
=Terminal year after tax cash flows						102100
Total Cash flow for the period		-644000	206420	232460	167360	252100
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631	1.5180704
Discounted CF=	Cashflow/discount factor	-644000	185963.96	188669.751	122372.19	166066.08
NPV=	Sum of discounted CF=	19071.983

Buy machine as NPV is positive