Geary Machine Shop is considering a four-year project to improve its production
ID: 2740729 • Letter: G
Question
Geary Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $700,800 is estimated to result in $233,600 in annual pretax cost savings. The press falls in the MACRS five-year class (MACRS Table), and it will have a salvage value at the end of the project of $102,200. The press also requires an initial investment in spare parts inventory of $29,200, along with an additional $4,380 in inventory for each succeeding year of the project.
If the shop's tax rate is 31 percent and its discount rate is 10 percent, what is the NPV for this project?
If the shop's tax rate is 31 percent and its discount rate is 10 percent, what is the NPV for this project?
Explanation / Answer
CALCULATION OF NET PRESENT VALUE OF GEARY MACHINE SHOP :
Cash outflows :
Buying a new machine press $ 700,800
Add: Initial investment in spare parts of inventory $ 29,200
TOTAL CASH OUTFLOWS : (A) $ 730,000
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Cash inflows:
Annual pretax cost savings $ 233,600
Less: Additional inventory cost each year $ 4,380
Less: Depreciation ($700,800-$102,200)/4 years $ 145,650
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Annual savings before tax $ 79,570
Less: Tax @ 31% $ 24,667
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$ 54,903
Add: Depreciation (non-cash item) $ 145,650
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Annual savings after tax $ 200,553
Discount factor @ 10%, 4 years 3.17
Annual savings * discount factor $ 635,753.01
Add: Salvage value $ 102,200 * 0.683 $ 69,802.60
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TOTAL CASH INFLOWS : (B) $ 705,555.61
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Therefore NET PRESENT VALUE IS (A-B) - $ 24,444.39
So, the COMPANY SHOULD NOT BUY THE MACHINE, AS THE NPV OF THE MACHINE IS NEGATIVE, HENCE NOT VIABLE.
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