Question

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.

Answer 1

Time line		0	1	2	3	4
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%	17.28%
Savings			145000	145000	145000	145000
-Depreciation	=Cost of machine*MACR%		-77000	-123200	-73920	-44352	66528	=Salvage Value
-working capital to be maintained			-3100	-3100	-3100	-3100
=Pretax cash flows			64900	18700	67980	97548
-taxes	=(Pretax cash flows)*(1-tax)		50622	14586	53024.4	76087.44
+Depreciation			77000	123200	73920	44352
=after tax operating cash flow			127622	137786	126944.4	120439.44
reversal of working capital						32400
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)					35100
+Tax shield on salvage book value	=Salvage value * tax rate					14636.16
=Terminal year after tax cash flows						82136.16
Total Cash flow for the period		-405000	127622.00	137786.0000	126944.40	202575.6
Discount factor=	(1+discount rate)^corresponding period	1	1.09	1.1881	1.295029	1.4115816
Discounted CF=	Cashflow/discount factor	-405000	117084.4037	115971.7196	98024.36857	143509.66
NPV=	Sum of discounted CF=	69590.15