Question

Masters Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $395,000 is estimated to result in $151,000 in annual pretax cost savings. The press falls in the MACRS five-year class, and it will have a salvage value at the end of the project of $51,000. The press also requires an initial investment in spare parts inventory of $22,000, along with an additional $3,200 in inventory for each succeeding year of the project. The shop’s tax rate is 22 percent and its discount rate is 9 percent. (MACRS schedule)

Calculate the NPV of this project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Initial Investment = $395,000
Useful Life = 4 years

Depreciation Year 1 = 20.00% * $395,000
Depreciation Year 1 = $79,000

Depreciation Year 2 = 32.00% * $395,000
Depreciation Year 2 = $126,400

Depreciation Year 3 = 19.20% * $395,000
Depreciation Year 3 = $75,840

Depreciation Year 4 = 11.52% * $395,000
Depreciation Year 4 = $45,504

Book Value at the end of Year 4 = $395,000 - $79,000 - $126,400 - $75,840 - $45,504
Book Value at the end of Year 4 = $68,256

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $51,000 - ($51,000 - $68,256) * 0.22
After-tax Salvage Value = $54,796.32

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$395,000 - $22,000
Net Cash Flows = -$417,000

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $151,000 * (1 - 0.22) + 0.22 * $79,000
Operating Cash Flow = $135,160

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $135,160 - $3,200
Net Cash Flows = $131,960

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $151,000 * (1 - 0.22) + 0.22 * $126,400
Operating Cash Flow = $145,588

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $145,588 - $3,200
Net Cash Flows = $142,388

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $151,000 * (1 - 0.22) + 0.22 * $75,840
Operating Cash Flow = $134,464.80

Net Cash Flows = Operating Cash Flow - Investment in NWC
Net Cash Flows = $134,464.80 - $3,200
Net Cash Flows = $131,264.80

Year 4:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $151,000 * (1 - 0.22) + 0.22 * $45,504
Operating Cash Flow = $127,790.88

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $127,790.88 + $31,600 + $54,796.32
Net Cash Flows = $214,187.20

Required Return = 9%

NPV = -$417,000 + $131,960/1.09 + $142,388/1.09^2 + $131,264.80/1.09^3 + $214,187.20/1.09^4
NPV = $77,005.47