Question

CSM Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $375,000 is estimated to result in $142,000 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 $45,000. The press also requires an initial investment in spare parts inventory of $15,000, along with an additional $2,000 in inventory for each succeeding year of the project. If the shop’s tax rate is 34 percent and its discount rate is 11 percent, should the company buy and install the machine press?

Answer 1

Answer:

the company should buy and install the press because the NPV of the project is positive ($73,133.75)

Explanation:

the MACRS 5 year depreciation:

1. $375,000 x 20% = $75,000
2. $375,000 x 32% = $120,000
3. $375,000 x 19.2% = $72,000
4. $375,000 x 11.52% = $43,200
5. $19,800, since salvage value at year 5 is $45,000
6. $0 x 5.76% = $0

salvage value $45,000

total initial investment = $375,000, discount rate = 11%

1. cash flow year 1 = {($142,000 - $15,000 - $75,000) x (1 - 34%)} + $75,000 = $109,320
2. cash flow year 2 = {($142,000 - $2,000 - $120,000) x (1 - 34%)} + $120,000 = $133,200
3. cash flow year 3 = {($142,000 - $2,000 - $72,000) x (1 - 34%)} + $72,000 = $116,880
4. cash flow year 4 = {($142,000 - $2,000 - $43,200) x (1 - 34%)} + $43,200 = $107,088
5. cash flow year 5 = {($142,000 - $2,000 - $19,800) x (1 - 34%)} + $19,800 + $45,000 = $144,132

the NPV of the project = -$375,000 + $109,320/1.11 + $133,200/1.11² + $116,880/1.11³ + $107,088/1.11⁴ + $144,132/1.11⁵ = $73,133.75