Warmack Machine Shop is considering a four-year project to improve its productio

Question

Warmack Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $450,000 is estimated to result in $180,000 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 $76,000. The press also requires an initial investment in spare parts inventory of $18,000, along with an additional $2,300 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and its discount rate is 9 percent. MACRS schedule

Calculate the NPV of this project.

Explanation / Answer

Under MACRS system of depreciation the capitalized cost of tangible property over the specified life by annual deductions of deprciation.

As per the MACRS schedule the depreciation is charged at the rate of 200% on declining balance as per the five year class.

The depreication rates are as following:

1st year = 20%

2nd Year =32%

3rd Year =19.20%

4th year = 11.52%

5th Year = 11.52%

So depreciation shall be computed in following manner:

1st Year- 4,50,000x 20% =90,000

2nd Year -4,50,000x32%=1,44,000

3rd Year- 4,50,000x19.2%=86,400

4th Year-4,50,000x11.52%=51,840

5th Year- 4,50,000x11.52%=51,840

Now the after tax profits shall be:

1st Year- (1,80,000-90,000)x (100-35%) = 58,500

2nd Year- (1,80,000-144,000)x (100-35%) =23,400

3rd Year-(1,80,000-86,400)x (100-35%) =60,840

4th Year-(1,80,000-51,840)x (100-35%) =63,804

5th Year-(1,80,000-51,840)x (100-35%) =63,804

Cash flows shall be sum of the net profit and savings and it shall be computed in following manner:

1st Year-58,500+90,000=1,48,500

2nd year-23,400+ 144,000=1,67,400

3rd Year-60,840+86,400=1,47,240

4th year-63,804+51,840=1,15,644

5th Year-63,804+51,840=1,15,644

Discounted cash flows shall be computed in following manner:

Note: In the 2ne Year $ 20,300 is deducted from the cash flows as they will be spent towards the inventory and spares.

NPV Computation:

Present Value of cash outflow- initial investment

468,241- 450,000 = 18,241

Since NPV is positive project should be accepted

Note: All the values are in $

Cash flows Discounted rate Present Value of
future cash flows year 1 148,500 0.9174 136,234 year 2 147,100 0.8417 123,814 Year 3 147,240 0.7722 113,699 year 4 115,644 0.7084 81,922 year 5 115,644 0.6499 75,157 year 6 Total 530,826 Less: Salvage Value 76,000 0.6499 49,392 Less: Investment in inventory and spares 20,300 0.6499 13,193 Net cash outflow 468,241

Related Questions

Navigate

• Browse (All)
• Browse W
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.