7. (10 points). A manufacturing engineer recommended a new jig to speed up drill

Question

7. (10 points). A manufacturing engineer recommended a new jig to speed up drilling for a special part. The initial cost was $3,500. The annual net savings due to the jig were found to be $1200 per year for 4 years. The IRS classifies jigs as three year property and allows depreciation deductions under the MACRS law over 4 years, but the company elected to use the straight line depreciation method instead over 4 years. The jig was fully depreciated in 4 years and no salvage value was considered. Tax rate was 25% and the MARR at the investment time was 4.05%. The management approved this purchase without any engineering economy analysis. To educate staff on engineering economy, this case was randomly selected for review by the management. A) First, carefully fill out the table below. The first row has column captions (4 pts) B) Calculate the NPV of the ATCF. Was this a good investment? (2 pts)

Explanation / Answer

Years 0 1 2 3 4 NPV Initial Cost -3,500.00 Annual Net Saving    1,200.00    1,200.00 1,200.00 1,200.00 Depreciation      -875.00      -875.00     -875.00     -875.00 EBT        325.00        325.00       325.00       325.00 Tax          81.25          81.25         81.25         81.25 PAT        243.75        243.75       243.75       243.75 Depreciation        875.00        875.00       875.00       875.00 OCF (ATCF)    1,118.75    1,118.75 1,118.75 1,118.75 FCF -3,500.00    1,118.75    1,118.75 1,118.75 1,118.75 Disc Fact. 1 0.9610764 0.9236679 0.887715 0.853162 Dis. Cash Flow -3,500.00    1,075.20    1,033.35       993.13       954.48      556.16 Since NPV is $556.16 which is >0, so it is a good investment Note: Even IRS classifies the depn dedcutions under MACRS however if company want to choose straight line methos they can Choose it but it would be better if company choosed MACRS method of depn Let's see NPV if company have choosen the MACRS method of depn Years 0 1 2 3 4 NPV Initial Cost -3,500.00 Annual Net Saving    1,200.00    1,200.00 1,200.00 1,200.00 Depreciation -1,166.55 -1,555.75     -518.35     -259.35 EBT          33.45      -355.75       681.65       940.65 Tax            8.36        -88.94       170.41       235.16 PAT          25.09      -266.81       511.24       705.49 Depreciation    1,166.55    1,555.75       518.35       259.35 OCF (ATCF)    1,191.64    1,288.94 1,029.59       964.84 FCF -3,500.00    1,191.64    1,288.94 1,029.59       964.84 Disc Fact. 1 0.9610764 0.9236679 0.887715 0.853162 Dis. Cash Flow -3,500.00    1,145.25    1,190.55       913.98       823.16      572.95 So if company would have adpoted MACRS method of Depn their NPV would be greater as compare to SLM method of Depn

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