Geary Machine Shop is considering a four-year project to improve its production
ID: 2740764 • Letter: G
Question
Geary Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $931,200 is estimated to result in $310,400 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 $135,800. The press also requires an initial investment in spare parts inventory of $38,800, along with an additional $5,820 in inventory for each succeeding year of the project.
If the shop's tax rate is 31 percent and its discount rate is 15 percent, what is the NPV for this project?
Geary Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $931,200 is estimated to result in $310,400 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 $135,800. The press also requires an initial investment in spare parts inventory of $38,800, along with an additional $5,820 in inventory for each succeeding year of the project.
Explanation / Answer
First of All We can Calculate the Depreciation for each year
1st Year Depreciation = $931200*.2000 = $186240
2nd Year Depreciation = $931200*.3200 = $297984
3rd Year Depreciation = $931200*.1920 = $178790
4th Year Depreciation = $931200*.1152 = $107274
Book Value at the end of Year 4 = $931200-($186240+$297984+$178790+$107274)
= $160911
Then we can find out the net salvage value
Salvage Value = $135800
Less Book value = $160911
Recapture of depreciation = ($25111)
Taxes @ 31% = ($7785)
Gross Salvage Value = $135800
Less taxes = ($7785)
Net Salvage Value = $143585
After this we can calculate Net income
Year
0
1
2
3
4
Savings
$310400
$310400
$310400
$310400
Depreciation
$186240
$297984
$178790
$107274
EBIT
$124160
$12416
$131610
$203126
Taxes @ 31%
$38490
$3849
$40799
$62969
Net Income
$85670
$8567
$90811
$140157
Then we can calculate Operating Cash Flow
Operating Cash Flow
EBIT
$124160
$12416
$131610
$203126
Add Depreciation
$186240
$297984
$178790
$107274
Less Taxes
$38490
$3849
$40799
$62969
Operating Cash Flow
$271910
$306551
$269601
$247431
Then We can calculate Capital Spending Cash Flow
Capital Spending
Initial Investment
($931200)
Net Working Capital
($38800)
($5820)
($5820)
($5820)
($5820)
Net Working Capital
$62080
Net Salvage Value
$143585
Capital Spending Cash Flow
($970000)
($5820)
($5820)
($5820)
$199845
After Calculating Capital Spending Cash Flow we can find total cash flow by adding it with operating cash flow
Total Cash Flow
Operating Cash Flow
$271910
$306551
$269601
$247431
Capital Spending Cash Flow
($970000)
($5820)
($5820)
($5820)
$199845
Total Cash Flow
($970000)
$266090
$300731
$263781
$447276
Now we can calculate NPV by using discount factor 15%
NPV = -970000 +$266090/1.15+$300731/1.15^2+263781/1.15^3+$447276/1.15^4
= -$82050
Year
0
1
2
3
4
Savings
$310400
$310400
$310400
$310400
Depreciation
$186240
$297984
$178790
$107274
EBIT
$124160
$12416
$131610
$203126
Taxes @ 31%
$38490
$3849
$40799
$62969
Net Income
$85670
$8567
$90811
$140157
Then we can calculate Operating Cash Flow
Operating Cash Flow
EBIT
$124160
$12416
$131610
$203126
Add Depreciation
$186240
$297984
$178790
$107274
Less Taxes
$38490
$3849
$40799
$62969
Operating Cash Flow
$271910
$306551
$269601
$247431
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