Cash Flow Estimation Problems Problem 4: please do not solve using excel Jupiter

Question

Cash Flow Estimation Problems Problem 4: please do not solve using excel

Jupiter Inc. is considering the purchase of a new machine which will reduce manufacturing costs by $5,000 annually. Jupiter will use the MACRS accelerated method to depreciate the machine, and it expects to sell it at the end of its 5-year operating life for $10,000. The firm expects to be able to reduce net operating working capital by $15,000 when the machine is installed, but required working capital will return to the original level when the machine is sold. Jupiter's marginal tax rate is 40 percent, and it uses a 12 percent cost of capital to evaluate projects of this nature.

If the machine costs $60,000, what is the project’s NPV? (MACRS 5 year schedule annual percentages: 20, 32, 19, 12, 11, and 6)

Explanation / Answer

In year 0, you have investment of 60,000 and reducing of NWC by 15,000. Net Cash Flows = -45,000

You save 5,000 for the next five years. Depreciation in each year = Investment x MACRS %

For year 1, Depreciation = 60,000 x 20% = 12,000 and so on for other years

Cash Flows = Investment + NWC + Net Income + Depreciation + After-tax Salvage Value

At the end of year 5, Book Value of the machine = Investment x (1 - accumulated depreciation)

= 6% x 60,000 = 3,600

After-tax Salvage Value = (Sale Price - Book Value) x (- Tax Rate) + Sale Price

= (10,000 - 3,600) x -40% + 10,000

= 7,440

Discounted Cash Flow (DCF) = Cash Flow / (1 + r)^n

For year 1, DCF = 7,800 / (1 + 12%)^1 = 6,964 and so on for other years

NPV = Sum of DCF = -21,493.24

Jupiter 0 1 2 3 4 5 MACRS 20% 32% 19% 12% 11% 6% Investment -60,000 3,600 NWC 15,000 -15,000 Salvage 10,000 Cost Savings 5,000 5,000 5,000 5,000 5,000 Depreciation -12,000 -19,200 -11,400 -7,200 -6,600 EBT -7,000 -14,200 -6,400 -2,200 -1,600 Tax (40%) 2,800 5,680 2,560 880 640 Net Income -4,200 -8,520 -3,840 -1,320 -960 Cash Flows -45,000 7,800 10,680 7,560 5,880 -1,920 DCF -45,000 6,964 8,514 5,381 3,737 -1,089 NPV -21,493.24

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