Question

The mayonnaise corporation estimates that it can save $30,000 a year in cash-operating costs for the next 4 years. If it buys a special-purpose machine at a cost of $100,000 to replace an old machine. No terminal disposal value is expected on the new machine. Assume an overall income tax rate of 35% and a minimum required rate of return of 16% after taxes. The new machine fits into the MACRS 3-year property class. Annual depreciation percentages for the 3-year MACRS property class are 33.33%, 44.45%, 14.81%, and 7.41%. the old machine, which had a book value of $5000, was sold to a scrap dealer for $9000. since the installation of the new machine required a shutdown of operations, inventory levels were increased by $12000 to cover sales. This increase in inventory will be released in the next year. Assume the overall company is profitable.

A. Prepare a cash flow profile (the textbook refers to cash flow profile as a “Net Present Value Analysis”). show your cash flows and compute the net present value and payback of the project. Would you accept or reject this project and why?

B. Briefly describe some sensitivities you might run on the NPV analysis above.

Answer 1

A.

Year	Initial investment (1)	Working capital (2)	Post-tax savage value (3)	Post-tax annual savings {30,000 x (1-tax rate)} (4)	Depreciation	Tax saving on depreciation (Dep. x 35%) (5)	Cashflow (6) = (1+2+3+4+5)	PV @ 16%	PV of Cashflow
1	(100,000)	(12,000)	7,600	19,500	33,330	11,665.5	(73,234.5)	0.86	(63,133.19)
2		12,000		19,500	44,450	15,557.5	47,057.5	0.74	34,971.39
3				19,500	14,810	5,183.5	24,683.5	0.64	15,813.67
4				19,500	7,410	2,593.5	22,093.5	0.55	12,202.04
									(146.09)

NET PRESENT VALUE = (146.09)

B.

1. Tax rate - Increase

2. Required rate of return - Increase

3. Annual savings - Decrease