Question

Geary Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $1,075,200 is estimated to result in $358,400 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 $156,800. The press also requires an initial investment in spare parts inventory of $44,800, along with an additional $6,720 in inventory for each succeeding year of the project. The tax rate is 34% and the discount is 15% what is NPV?

Answer 1

There are 3 components we need to find the NPV :

1. Total Initial Outlay

2. Cash Flows

3. Terminal Value

1. Total Intial Outlay = Intial investment + investment in inventory (working capital)

2. Cash flow = (cost savings - investment required for inventory) * (1-tax rate) + Depreciation * Tax rate

3. Terminal Value = Salavge value + Net working capital - tax*(salvage value - Book value)

Book Value is calculated by substracting the total depreciation from the initial investment

Here Net working capital is investment in inventory spares.