Thornley Machines is considering a 3-year project with an initial cost of $840,0

Question

Thornley Machines is considering a 3-year project with an initial cost of $840,000. The project will not directly produce any sales but will reduce operating costs by $435,000 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 $90,000. The tax rate is 34 percent. The project will require $22,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 10 percent? Why or why not?

yes; The NPV is $74,000.00

yes; The NPV is $65,335.09

yes; The NPV is $149,880.54

no; The NPV is $171,880.54

yes; The NPV is $229,996.24

Thornley Machines is considering a 3-year project with an initial cost of $840,000. The project will not directly produce any sales but will reduce operating costs by $435,000 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 $90,000. The tax rate is 34 percent. The project will require $22,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 10 percent? Why or why not?

Explanation / Answer

Annual depreciation = $840,000 / 3 = $280,000

Cash flow t = 0 = - ($840,000 + $22,000) = -$ 862,000

Cash flow t = 1 = {[$0 - (-$435,000)] × (1 - 0.34)} + ($280,000 × 0.34) = $382,300

Cash flow t = 2 = $382,300

Cash flow t = 3 = $382,300 + $90,000 × (1 - 0.34) + $22,000 = $463,700

NPV = -$862,000 + $382,300 / (1 + 0.1) + $382,300 / (1 + 0.1)2 + $463,700 / (1 + 0.1)3 = $149,880.54

yes; The NPV is $149,880.54

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