Question

Masters Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $902,400 is estimated to result in $300,800 in annual pretax cost savings. The press falls in the MACRS five-year class (MACRS Table), and it will have a salvage value at the end of the project of $131,600. The press also requires an initial investment in spare parts inventory of $37,600, along with an additional $5,640 in inventory for each succeeding year of the project.

  

If the shop's tax rate is 22 percent and its discount rate is 11 percent, what is the NPV for this project?

Answer 1

Time line		0	1	2	3	4
Cost of new machine		-902400
Initial working capital		-37600
=Initial Investment outlay		-940000
5 years MACR rate			20.00%	32.00%	19.20%	11.52%	17.28%
Profits			300800	300800	300800	300800
-Depreciation	=Cost of machine*MACR%		-180480	-288768	-173260.8	-103956.5	155934.72	=Salvage Value
-working capital to be maintained			-5640	-5640	-5640	-5640
=Pretax cash flows			114680	6392	121899.2	191203.52
-taxes	=(Pretax cash flows)*(1-tax)		89450.4	4985.76	95081.376	149138.75
+Depreciation			180480	288768	173260.8	103956.48
=after tax operating cash flow			269930.4	293753.8	268342.18	253095.23
reversal of working capital						60160
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)					102648
+Tax shield on salvage book value	=Salvage value * tax rate					34305.638
=Terminal year after tax cash flows						197113.64
Total Cash flow for the period		-940000	269930.4	293753.8	268342.18	450208.86
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631	1.5180704
Discounted CF=	Cashflow/discount factor	-940000	243180.5	238417.1	196209.49	296566.52
NPV=	Sum of discounted CF=	34373.69189