Question

Carlson Machine Shop is considering a four-year project to improve its production efficiency by purchasing a new machine press for $480,000 that will result in $160,000 in annual pre-tax cost savings. The press will be depreciated using the 5-year MACRS depreciation schedule and management expects to be able to sell it for $70,000 at the end of four years. The new press will require an initial inventory of $20,000 with an additional $3,000 in spare parts inventory required each year of the project. Carlson has a 14% cost of capital and a 35% tax rate. Should the company buy the machine?

Answer 1

Depreciation: (480,000 - 0) / 5 = $96,000

OFC(1-4): 160,000 * (1-35%) + 35% x 96,000 = $137,600

BV4 = 480,000 - 96000 * 4 = 96,000

After Tax Salvage Value: 70,000 - 35% * (70,000 - 96000) = $79,100

----------- 0 -------- 1 ---------- 2 -------- 3 ----- 4

NWC __20000_____23000_____26000____29000______0

ΔNWC 20000____3000_____3000______3000___-29000

------- ___Year 0 __________Year 1-3 ______________Year 4

---OCF ____0 ______________137,600 ______________ 137,600

---NCS -480,000 ___________0 ___________________ 79,000

-ΔNWC -20,000 ____________-3,000 _____________ +29,000

--------- ---------- ----------- -------------------

Total CF -500,000 _______134,600 _______________247,500

_______________CF0 ________CF1, FO1=3; _____CF2, FO2 = 1;

I = 14% -> NPV = -42,034

-42,034 < 0 = REJECT