Thornley Machines is considering a 3-year project with an initial cost of $900,0

Question

Thornley Machines is considering a 3-year project with an initial cost of $900,000. The project will not directly produce any sales but will reduce operating costs by $445,000 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 $96,000. The tax rate is 34 percent. The project will require $24,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 12 percent? Why or why not?

Explanation / Answer

Year Cash outflow Cash inflow(savings) Depriciation Net cash saving Tax @34% Net cash inflow Net cash flow A B C D=B-C E = D*34% F = D -E + C F - A 0 900000 -900000 1 24000 445000 300000 145000 49300 395700 371700 2 24000 445000 300000 145000 49300 395700 371700 3 24000 541000 300000 241000 81940 459060 435060 24000 every year is for extra inventory Depriciatiob = 900000/3 = 300000 pa 3rd year cash inflow includes 96000 for value of equipment sold NPV = CF1/(1+i)^1 + CF2/(1+i)^2 + CF3/(1+i)^3-initial investment           = 371700/(1+0.12)^1 + 371700/(1+0.12)^2 + 435060/(1+0.12)^3 - 900000           = 371700/1.12 + 371700 /1.2544 + 435060 /1.4049 - 900000          = 937865.25-900000          = 37865.25 As NPV is positive at requred rate of return of 12%, the project should be undertaken

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