Question

Masters Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $455,000 is estimated to result in $187,000 in annual pretax cost savings. The press falls in the MACRS five-year class, and it will have a salvage value at the end of the project of $75,000. The press also requires an initial investment in spare parts inventory of $34,000, along with an additional $3,800 in inventory for each succeeding year of the project. The shop’s tax rate is 24 percent and its discount rate is 9 percent. (MACRS schedule)

Calculate the NPV of this project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Initial Investment = $455,000
Useful Life = 4 years

Depreciation Year 1 = 20.00% * $455,000
Depreciation Year 1 = $91,000

Depreciation Year 2 = 32.00% * $455,000
Depreciation Year 2 = $145,600

Depreciation Year 3 = 19.20% * $455,000
Depreciation Year 3 = $87,360

Depreciation Year 3 = 11.52% * $455,000
Depreciation Year 3 = $52,416

Book Value at the end of Year 4 = $455,000 - $91,000 - $145,600 - $87,360 - $52,416
Book Value at the end of Year 4 = $78,624

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $75,000 - ($75,000 - $78,624) * 0.24
After-tax Salvage Value = $75,869.76

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$455,000 - $34,000
Net Cash Flows = -$489,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $187,000 * (1 - 0.24) + 0.24 * $91,000
Operating Cash Flow = $163,960

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $163,960 - $3,800
Net Cash Flows = $160,160

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $187,000 * (1 - 0.24) + 0.24 * $145,600
Operating Cash Flow = $177,064

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $177,064 - $3,800
Net Cash Flows = $173,264

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $187,000 * (1 - 0.24) + 0.24 * $87,360
Operating Cash Flow = $163,086.40

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $163,086.40 - $3,800
Net Cash Flows = $159,286.40

Year 4:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $187,000 * (1 - 0.24) + 0.24 * $52,416
Operating Cash Flow = $154,699.84

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $154,699.84 + $45,400 + $75,869.76
Net Cash Flows = $275,969.60

Required Return = 9%

NPV = -$489,000 + $160,160/1.09 + $173,264/1.09^2 + $159,286.40/1.09^3 + $275,969.60/1.09^4
NPV = $122,270.77

So, NPV of this project is $122,270.77