Question

Geary Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $547,200 is estimated to result in $182,400 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 $79,800. The press also requires an initial investment in spare parts inventory of $22,800, along with an additional $3,420 in inventory for each succeeding year of the project.

  

Required :

If the shop's tax rate is 32 percent and its discount rate is 13 percent, what is the NPV for this project? (Do not round your intermediate calculations.)

Answer 1

Step 1 calculate the depreciation schedule:

Depreciation Schedule as Per MACRS 5 year rates
Year	Opening Balance	Investment	Depreciation	Closing Balance
0		547200		547200
1	547200		0.2*547200=109440	437760
2	437760		0.32*547200=175104	262656
3	262656		0.192*547200=105062.4	157593.6
4	157593.6		0.1152*547200=63037.44	94556.16
5	94556.16		0.1152*547200=63037.44	31518.72
6	31518.72		0.0576*547200=31518.72	0

• Opening balance = previous year's closing balance
• Closing balance = opening balance+investment-depreciation

Step 2 CF schdule and NPV calculation:

CF schedule
Year	Remark	0	1	2	3	4
Pretax savings	Given		182400	182400	182400	182400
Depreciation	Calculated above		109440	175104	105062.4	63037.44
EBIT	Pretax savings-Depreciation		72960	7296	77337.6	119362.56
Tax	32% x EBIT		23347.2	2334.72	24748.032	38196.0192
EAT	EBIT-Tax		49612.8	4961.28	52589.568	81166.5408
Depreciation	Added back as non cash expense		109440	175104	105062.4	63037.44
Initial investment	Given	-547200
WCINV	Given	-22800	-3420	-3420	-3420	-3420
WCINV Recovery	As per convention					36480
Salvage Value	Given					79800
Tax on profit	32% x (salvage value-book value at the end of year 4)					-4426.848
CF	EAT+Depreciation+Investment+WCINV+WCINV recovery+Salvage value+Tax on profit	-570000	155632.8	176645.28	154231.968	252637.1328
Discount factor formula		1/1.13^0	1/1.13^1	1/1.13^2	1/1.13^3	1/1.13^4
Discount factor		1	0.884955752	0.783146683	0.693050162	0.613318728
DCF	CF x Discount factor	-570000	137728.1416	138339.1652	106890.4905	154947.0849
NPV = Sum of all Discounted CF		-32095.11794

NPV = -32095.12, as it is negative, the project is not worth investing.