Question

13. Cost-Cutting Proposals Starset Machine Shop is clsidering a 4-year project to improve its production efficiency. Buying a new machine press for $670,000 is estimated to result in $245,000 in annual pretax cost savings. The press falls in the 5-year MACRS class, and it will have a salvage value at the end of the project of $55,000. The press also requires an initial investment in spare parts inventory of $20,000, along with an additional $2,500 in inventory for each succeeding year of the project. If The shop's tax rate is 23 percent and the discount rate is 8 percent, should the company buy and install the machine press? 14. NPV and Bonus Depreciation In the previous problem, suppose the fixed asset actually qualifies for 100 percent bonus depreciation. All the other facts are the same. What is the new NPV?

Q 13/14 are related witount excal

Answer 1

13

Time line		0	1	2	3	4
Cost of new machine		-670000
Initial working capital		-20000
=Initial Investment outlay		-690000
5 years MACR rate			20.00%	32.00%	19.20%	11.52%	17.28%
Savings			245000	245000	245000	245000
-Depreciation	=Cost of machine*MACR%		-134000	-214400	-128640	-77184	115776	=Salvage Value
-working capital to be maintained			-2500	-2500	-2500	-2500
=Pretax cash flows			108500	28100	113860	165316
-taxes	=(Pretax cash flows)*(1-tax)		83545	21637	87672.2	127293.32
+Depreciation			134000	214400	128640	77184
=after tax operating cash flow			217545	236037	216312.2	204477.32
reversal of working capital						30000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)					42350
+Tax shield on salvage book value	=Salvage value * tax rate					26628.48
=Terminal year after tax cash flows						98978.48
Total Cash flow for the period		-690000	217545	236037	216312.2	303455.8
Discount factor=	(1+discount rate)^corresponding period	1	1.08	1.1664	1.259712	1.360489
Discounted CF=	Cashflow/discount factor	-690000	201430.5556	202363.6831	171715.5985	223049.07
NPV=	Sum of discounted CF=	108558.91

14

Time line		0	1	2	3	4
Cost of new machine		-670000
Initial working capital		-20000
=Initial Investment outlay		-690000
							100.00%
Savings			245000	245000	245000	245000
-Depreciation			-670000	0	0	0	0	=Salvage Value
-working capital to be maintained			-2500	-2500	-2500	-2500
=Pretax cash flows			-427500	242500	242500	242500
-taxes	=(Pretax cash flows)*(1-tax)		-329175	186725	186725	186725
+Depreciation			670000	0	0	0
=after tax operating cash flow			340825	186725	186725	186725
reversal of working capital						30000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)					42350
+Tax shield on salvage book value	=Salvage value * tax rate					0
=Terminal year after tax cash flows						72350
Total Cash flow for the period		-690000	340825	186725	186725	259075
Discount factor=	(1+discount rate)^corresponding period	1	1.08	1.1664	1.259712	1.360489
Discounted CF=	Cashflow/discount factor	-690000	315578.7037	160086.5912	148228.3252	190427.86
NPV=	Sum of discounted CF=	124321.48