Question

Geary Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $873,600 is estimated to result in $291,200 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 $127,400. The press also requires an initial investment in spare parts inventory of $36,400, along with an additional $5,460 in inventory for each succeeding year of the project.

  

Required :

If the shop's tax rate is 35 percent and its discount rate is 17 percent, what is the NPV for this project? (Do not round your intermediate calculations.)

  
rev: 09_18_2012

$-123,077.88

$-119,754.73

$-204,206.20

$-129,231.77

$-116,923.98

Answer 1

Initial Investment = $873,600
Useful Life = 4 years

Depreciation Year 1 = 20.00% * $873,600
Depreciation Year 1 = $174,720

Depreciation Year 2 = 32.00% * $873,600
Depreciation Year 2 = $279,552

Depreciation Year 3 = 19.20% * $873,600
Depreciation Year 3 = $167,731.20

Depreciation Year 4 = 11.52% * $873,600
Depreciation Year 4 = $100,638.72

Book Value at the end of Year 4 = $873,600 - $174,720 - $279,552 - $167,731.20 - $100,638.72
Book Value at the end of Year 4 = $150,958.08

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $127,400 - ($127,400 - $150,958.08) * 0.35
After-tax Salvage Value = $135,645.328

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$873,600 - $36,400
Net Cash Flows = -$910,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $291,200 * (1 - 0.35) + 0.35 * $174,720
Operating Cash Flow = $250,432

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $250,432 - $5,460
Net Cash Flows = $244,972

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $291,200 * (1 - 0.35) + 0.35 * $279,552
Operating Cash Flow = $287,123.20

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $287,123.20 - $5,460
Net Cash Flows = $281,663.20

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $291,200 * (1 - 0.35) + 0.35 * $167,731.20
Operating Cash Flow = $247,985.92

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $247,985.92 - $5,460
Net Cash Flows = $242,525.92

Year 4:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $291,200 * (1 - 0.35) + 0.35 * $100,638.72
Operating Cash Flow = $224,503.55

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $224,503.55 + $52,780 + $135,645.328
Net Cash Flows = $412,928.878

Required Return = 17%

NPV = -$910,000 + $244,972/1.17 + $281,663.20/1.17^2 + $242,525.92/1.17^3 + $412,928.878/1.17^4
NPV = -$123,077.88

So, NPV of this project is -$123,077.88