Exercise Three (4 points) Pluto Corp. is considering investing in an automated m

Question

Exercise Three (4 points) Pluto Corp. is considering investing in an automated manufacturing line. Installation of the line will cost $2,440,000 and must be paid up front. It will be depreciated using straight-line depreciation and is expected to last four years and have a salvage value of $225,000. The increase in contribution margin from having the automated line for each year are expected to be as follows: Year 1 $600,000 Year 2 $800,000 Year 3 - $800,000 Year 4-$900,000 Pluto is subject to a 20% tax rate and uses a discount rate of 8% when making investment decisions. What is the NPV of the investment in an automated line: Given your calculation, what would you recommend that the company do?

Explanation / Answer

Since NPV is positivve, it is recommended to invest in automated manufacturing line.

Calculation of NPV: Year Contribution Margin Depreciation Profit Tax Profit after tax Cash Flow after tax PVF (8%) PV of CF 0 -2440000 1 -2440000 1 600000 553750 46250 9250 37000 590750 0.925926 546990.7 2 800000 553750 246250 49250 197000 750750 0.857339 643647.1 3 800000 553750 246250 49250 197000 750750 0.793832 595969.6 4 900000 553750 346250 69250 277000 830750 0.73503 610626.1 4 225000 0.73503 165381.7 122615.2

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