Thornley Machines is considering a 3-year project with an initial cost of $690,0
ID: 2717615 • Letter: T
Question
Thornley Machines is considering a 3-year project with an initial cost of $690,000. The project will not directly produce any sales but will reduce operating costs by $405,000 a year. The equipment is depreciated straight-line to a zero book value over the life of the project. At the end of the project the equipment will be sold for an estimated $75,000. The tax rate is 34 percent. The project will require $17,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 13 percent? Why or why not?
yes; The NPV is $154,866.06
yes; The NPV is $125,500.00
yes; The NPV is $219,707.03
no; The NPV is $171,866.06
yes; The NPV is $64,412.62
Thornley Machines is considering a 3-year project with an initial cost of $690,000. The project will not directly produce any sales but will reduce operating costs by $405,000 a year. The equipment is depreciated straight-line to a zero book value over the life of the project. At the end of the project the equipment will be sold for an estimated $75,000. The tax rate is 34 percent. The project will require $17,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 13 percent? Why or why not?
Explanation / Answer
Calculation of NPV of the project:
Year
Cash Flows (CF)
PVF (13%)
PV = CF *PVF
Initial Cost
0
$ (690,000.00)
1.00000
$ (690,000.00)
Initial investment in inventories
0
$ (17,000.00)
1.00000
$ (17,000.00)
Reduction in Annual operating costs (Net of Tax) = 405000*(1-34%)
1 to 3
$ 267,300.00
2.36115
$ 631,136.09
Annual tax saving on depreciation
1 to 3
$ 78,200.00
2.36115
$ 184,642.13
= ((Cost- Salvage value ) / life )*Tax rate
((690000-0) / 3 ) *34%
Sale value net of tax = 75000*(1-34%)
3
$ 49,500.00
0.69305
$ 34,305.98
Investment in inventories releases
3
$ 17,000.00
0.69305
$ 11,781.85
NPV = Sum of PVs
$ 154,866.06
The NPV is positive $154866.06, hence the project should be implemented.
Calculation of NPV of the project:
Year
Cash Flows (CF)
PVF (13%)
PV = CF *PVF
Initial Cost
0
$ (690,000.00)
1.00000
$ (690,000.00)
Initial investment in inventories
0
$ (17,000.00)
1.00000
$ (17,000.00)
Reduction in Annual operating costs (Net of Tax) = 405000*(1-34%)
1 to 3
$ 267,300.00
2.36115
$ 631,136.09
Annual tax saving on depreciation
1 to 3
$ 78,200.00
2.36115
$ 184,642.13
= ((Cost- Salvage value ) / life )*Tax rate
((690000-0) / 3 ) *34%
Sale value net of tax = 75000*(1-34%)
3
$ 49,500.00
0.69305
$ 34,305.98
Investment in inventories releases
3
$ 17,000.00
0.69305
$ 11,781.85
NPV = Sum of PVs
$ 154,866.06
The NPV is positive $154866.06, hence the project should be implemented.
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