Question

Geary Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $1,027,200 is estimated to result in $342,400 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 $149,800. The press also requires an initial investment in spare parts inventory of $42,800, along with an additional $6,420 in inventory for each succeeding year of the project.

  

Required :

If the shop's tax rate is 32 percent and its discount rate is 15 percent, what is the NPV for this project? (Do not round your intermediate calculations.)

Answer 1

Initial Investment = $1,027,200
Useful Life = 4 years

Depreciation Year 1 = 20.00% * $1,027,200
Depreciation Year 1 = $205,440

Depreciation Year 2 = 32.00% * $1,027,200
Depreciation Year 2 = $328,704

Depreciation Year 3 = 19.20% * $1,027,200
Depreciation Year 3 = $197,222.40

Depreciation Year 4 = 11.52% * $1,027,200
Depreciation Year 4 = $118,333.44

Book Value at the end of Year 4 = $1,027,200 - $205,440 - $328,704 - $197,222.40 - $118,333.44
Book Value at the end of Year 4 = $177,500.16

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $149,800 - ($149,800 - $177,500.16) * 0.32
After-tax Salvage Value = $158,664.05

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$1,027,200 - $42,800
Net Cash Flows = -$1,070,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $342,400 * (1 - 0.32) + 0.32 * $205,440
Operating Cash Flow = $298,572.80

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $298,572.80 - $6,420
Net Cash Flows = $292,152.80

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $342,400 * (1 - 0.32) + 0.32 * $328,704
Operating Cash Flow = $338,017.28

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $338,017.28 - $6,420
Net Cash Flows = $331,597.28

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $342,400 * (1 - 0.32) + 0.32 * $197,222.40
Operating Cash Flow = $295,943.17

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $295,943.17 - $6,420
Net Cash Flows = $289,523.17

Year 4:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $342,400 * (1 - 0.32) + 0.32 * $118,333.44
Operating Cash Flow = $270,698.70

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $270,698.70 + $62,060 + $158,664.05
Net Cash Flows = $491,422.75

Required Return = 15%

NPV = -$1,070,000 + $292,152.80/1.15 + $331,597.28/1.15^2 + $289,523.17/1.15^3 + $491,422.75/1.15^4
NPV = -$93,880.17

So, NPV of this project is -$93,880.17