A manufacturer of aerospace products acquired a new multispindle, multi-turret t

Question

A manufacturer of aerospace products acquired a new multispindle, multi-turret turning center for $250,000. The machine will generate new revenue of $80,000 per year. Operating costs for the machine will average $10,000 per year. The machine will be depreciated using the MACRS method, with a recovery period of 7 years. The useful life of the turning center is 10 years; it is estimated that its salvage value will be $25,000 at this time. The company uses an after-tax MARR rate of 12% and is in the 35% tax bracket.

Now, suppose that the project duration is 5 years and that an estimate of the value of the equipment cannot be obtained from the marketplace. What is the breakeven salvage value?

Explanation / Answer

Answer:

The breakeven salvage value will be the value required to equate present value of cash inflows with present value of cash outflows or to make NPV = 0

Now,

Present Value of Cash Outflows = $ 250,000

Present Value of Cash Inflows = $ 80,000 - $ 10,000 - {(250,000 - 25000) / 7} - 35% tax + {(250,000 - 25000) / 7}] x PVAF@12% for 5 years = [$ 70,000 - $ 32,143 - 35% tax + $ 32,143] x 3.605 = $ 56,750.05 x 3.605 = $ 204,583.93 or $ 204,584

NPV = $ 204,584 - $ 250,000 = $ 45,416.06

That is present value of salvage value receivable at the end of 5 years shall be equal to $ 45,416.06 therefore, the salvage value = $ 45,416.06 / PVF@12% for 5th year = $ 45,416.06 / 0.567 = $ 80,099.

Thus, the Breakeven Salvage Value = $ 80,099

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