Question

A proposed cost-saving device has an installed cost of $815,000. The device will be used in a five-year project but is classified as three-year MACRS property for tax purposes. The required initial net working capital investment is $87,000, the marginal tax rate is 21 percent, and the project discount rate is 11 percent. The device has an estimated Year 5 salvage value of $133,000. What level of pretax cost savings do we require for this project to be profitable? MACRS schedule (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

1)	Initial cost of the project = 815000+87000 =				$ 902,000.00
2)	Terminal non operating cash flow = 133000*(1-0.21)+87000 =				$ 192,070.00
	PV of terminal non operating cash flows = 192070/1.11^5 =				$ 113,984.20
3)	PV of depreciation tax shields:
	Year	Depreciation Rate	Depreciation	Tax shield on Depreciation	PVIF at 11%	PV
	1	33.33	271639.50	57044.30	0.90090	51391.26
	2	44.45	362267.50	76076.18	0.81162	61745.13
	3	14.81	120701.50	25347.32	0.73119	18533.74
	4	7.41	60391.50	12682.22	0.65873	8354.17
	5	0	0.00	0.00	0.59345	0.00
					3.69590	140024.29
	For NPV = 0,
	PV of depreciation tax shields+PV of after tax cost savings+PV of non operating
	terminal cash flow-Initial cost = 0
	Rearranging the above equation and giving available values we have
	PV of after tax cost savings = 902000-113984.20-140024.29 =				$ 647,991.51
	After tax annual cost savings = 647991.51/3.69590 =				$ 175,327.12
	Pretax annual cost savings = 175327.12/0.79 =				$ 221,933.07	Answer
	Answer:
	The pretax cost savings should be more than $221,933.07