Question

Chapman Machine Shop is considering a 4-year project to improve its production efficiency. Buying a new machine press for $576,000 is estimated to result in $192,000 in annual pretax cost savings. The press falls in the MACRS 5-year class, and it will have a salvage value at the end of the project of $84,000. The press also requires an initial investment in spare parts inventory of $24,000, along with an additional $3,600 in inventory for each succeeding year of the project. The inventory will return to its original level when the project ends. The shop's tax rate is 35% and its discount rate is 11%. Should the firm buy and install the machine press? Assume that Chapman machine shop is expected to grow at a rate of 3% after year 4. If the value of debt is $150,000, and there are 50,000 shares outstanding, what is the price per share of Chapman’s common stock?

Answer 1

Chapman	0	1	2	3	4
MACRS %		20%	32%	19.20%	11.52%	17.28%
Investment	-576,000					99532.8
NWC	-24,000	-3,600	-3,600	-3,600	34,800
Salvage					84,000
Savings		192,000	192,000	192,000	192,000
Depreciation		-115,200	-184,320	-110,592	-66,355
EBT		76,800	7,680	81,408	125,645
Tax (35%)		-26,880	-2,688	-28,493	-43,976
Net Income		49,920	4,992	52,915	81,669
Cash Flows	-600,000	161,520	185,712	159,907	272,261
NPV	-$7,489.07

Here, depreciation = MACRS % x Investment

Cash Flows = Investment + NWC + After tax Salvage Value + Net Income + Depreciation

NPV can be calculated using the same function using 11% discount rate and the above cash flows.

As NPV < 0, the firm should not buy and install the machine press.