Question

A proposed cost-saving device has an installed cost of $685,000.
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 $95,000, the marginal tax rate is
23 percent, and the project discount rate is 13 percent. The device
has an estimated Year 5 salvage value of $74,000. What level of
pretax cost savings do we require for this project to be
profitable? MACRS schedule. |

Pretax cost savings |

Answer #1

Answer : Pretax cost savings : **$211382**

Explanation:

Investment in fixed assets + Investment in NWC = Pretax cost savings*(1-t)*PVAF(13% for 5 year) + PV of dep tax shield + PV of salvage + NWC Recovered

Let x be the pretax cost savings, then:

685000 + 95000 = x*(1-0.23)* 3.517231261542 + 125033 + 30926 + 51562

780000 =2.708268071387x + 207521

x = 572479 / 2.708268071387

x = $211382

Calculation of PV of Depreciation :

Year 1 Dep. = 685000 * 33.33% * PVF @13%, 1st Year * Tax rate = 46470

Year 2 Dep. = 685000 * 44.45% * PVF @13%, 2nd Year * Tax rate = 54845

Year 3 Dep. = 685000 * 14.81% * PVF @13%, 3rd year * Tax rate= 16171

Year 4 Dep. = 685000 * 7.41% * PVF @13%, 4th year * Tax rate = 7547

Total PV of dep = 125033

PV of salvage = Salvage Value * ( 1 - t) * PVF @ 13%, 5th year

PV of salvage = 74000 * ( 1 - 0.23 ) * 0.5428

PV of salvage = 30926

PV of NWC = NWF * PV@13%, 5th year

PV of NWC = 95000 * 0.5428

PV of NWC = 51562

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