Warmack Machine Shop is considering a four-year project to improve its productio

Question

Warmack Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $520,000 is estimated to result in $215,000 in annual pretax cost savings. The press falls in the MACRS five-year class, and it will have a salvage value at the end of the project of $87,000. The press also requires an initial investment in spare parts inventory of $25,000, along with an additional $3,000 in inventory for each succeeding year of the project. The shop’s tax rate is 34 percent and its discount rate is 10 percent.Calculate NPV

Explanation / Answer

Time line 0 1 2 3 4 5 Cost of equipment -520000 Installation cost 0 Total investment in new machine -520000 Increase in working capital -25000 -3000 -3000 -3000 -3000 =Initial Investment outlay -545000 Savings= 215000 215000 215000 215000 MACR rate 20% 32% 19.20% 11.52% 17.28% -Depreciation MACR Rate* total investment 104000 166400 99840 59904 89856 =salvage book value -additional NWC'= 111000 48600 115160 155096 -taxes =(Profit- depreciation)*(1-tax) 73260 32076 76005.6 102363.4 +Depreciation 104000 166400 99840 59904 =after tax operating cash flow 177260 198476 175845.6 162267.4 Reversal of W/C 37000 Proceeds from sale of assets =salvage value*(1 - tax rate) 57420 +Salvage book value * tax rate 30551.04 Terminal year non operating cash flows 124971 Total Cash flow for the period -545000 174260 195476 172845.6 287238.4 Discount factor =(1+discount rate)^n 1 1.1 1.21 1.331 1.4641 Discount rate= 10% Discounted cash flows -545000 158418.2 161550.4 129861.5 196187.7 NPV= Sum of discounted cash flows 101017.74

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