Question

Cambridge Analytics is considering a four-year project to improve its production efficiency. Buying a new machine press for $600,000 is estimated to result in $210,000 pretax cost savings annually. The press will be depreciated equally to zero per year and can be sold for $80,000 at the end of its life. The press also requires an initial investment in inventory of $20,000, and the level of inventory increases by $3,000 every year. Tax rate is 17% and the discount rate is 9%. Should the company undertake the project?

Answer 1

Time line		0	1	2	3	4
Cost of new machine		-600000
-Initial working capital		-20000
=Initial Investment outlay		-620000
Savings			210000	210000	210000	210000
-Depreciation	Cost of equipment/no. of years = -600000/4		-150000	-150000	-150000	-150000
-working capital to be maintained			-3000	-3000	-3000	-3000
=Pretax cash flows			57000	57000	57000	57000
-taxes	=(Pretax cash flows)*(1-tax) = 57000*(1-0.17)=		47310	47310	47310	47310
+Depreciation			150000	150000	150000	150000
=after tax operating cash flow			197310	197310	197310	197310
reversal of working capital					=20000+4*3000=	32000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				=80000*(1-0.17)=	66400
+Tax shield on salvage book value	=Salvage value * tax rate					0
=Terminal year after tax cash flows						98400
Total Cash flow for the period		-620000	197310	197310	197310	295710
Discount factor=	(1+discount rate)^corresponding period=(1+0.09)^n=	1	1.09	1.1881	1.295029	1.4115816
Discounted CF=	Cashflow/discount factor	-620000	181018.3	166071.9	152359.52	209488.42
NPV=	Sum of discounted CF=	88938.16971

Accept project as NPV is positive