Question

# Chapman Machine Shop is considering a 4-year project to improve its production efficiency. Buying a new...

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?

 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.

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