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Masters Machine Shop is considering a four-year project to improve its production efficiency. Buying a new...

Masters Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $385,000 is estimated to result in $145,000 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 $45,000. The press also requires an initial investment in spare parts inventory of $20,000, along with an additional $3,100 in inventory for each succeeding year of the project. The shop’s tax rate is 22 percent and its discount rate is 9 percent. Refer to Table 10.7. Calculate the NPV of this project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) (NOTE: show CF function inputs to find the NPV) Should the company buy and install the machine press? Yes No

Solutions

Expert Solution

Time line 0 1 2 3 4 5
Cost of new machine -385000
Initial working capital -20000
=Initial Investment outlay -405000
5 years MACR rate 20.00% 32.00% 19.20% 11.52% 11.5200% 0.0576 0
Savings 145000 145000 145000 145000 145000
-Depreciation =Cost of machine*MACR% -77000 -123200 -73920 -44352 -44352 22176 =Salvage Value
-working capital to be maintained -3100 -3100 -3100 -3100 -3100
=Pretax cash flows 64900 18700 67980 97548 97548
-taxes =(Pretax cash flows)*(1-tax) 50622 14586 53024.4 76087.44 76087.44
+Depreciation 77000 123200 73920 44352 44352
=after tax operating cash flow 127622 137786 126944.4 120439.44 120439.44
reversal of working capital 35500
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 35100
+Tax shield on salvage book value =Salvage value * tax rate 4878.72
=Terminal year after tax cash flows 75478.72
Total Cash flow for the period -405000 127622 137786 126944.4 120439.44 195918.16
Discount factor= (1+discount rate)^corresponding period 1 1.09 1.1881 1.295029 1.4115816 1.538624
Discounted CF= Cashflow/discount factor -405000 117084.4 115971.72 98024.369 85322.336 127333.36
NPV= Sum of discounted CF= 138736.189

Buy press as NPV is positive


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