Question

Starset Machine Shop is considering a 4-year project to improve its production efficiency. Buying a new machine press for $425,000 is estimated to result in $169,000 in annual pretax cost savings. The press falls in the 5-year MACRS class, and it will have a salvage value at the end of the project of $69,000. The press also requires an initial investment in spare parts inventory of $28,000, along with an additional $3,500 in inventory for each succeeding year of the project. The shop’s tax rate is 23 percent and its discount rate is 10 percent.
1. Calculate the NPV of this project.
2. Should the company buy and install the machine press?
A. No.
B. Yes.

Answer 1

Answer:

96,287

Explanation:

Cost of Machine $425,000

5 years MACRS rate is

Year 1 - 425,000 * 20% = 85,000

Year 2 - 425,000 * 32% = 136,000

Year 3 - 425,000 * 19.20% = 81,600

Year 4 - 425,000 * 11.52% = 48,960

Total depreciation in 4 years = 351,560

New Book Value of asset = 73,440

Salvage value at the end of 4 years = 69,000

Gain on disposal = 4,440

The NPV can be calculated based on tax savings

169000 for 4 years using annuity at 23% rate.

The NPV of the project is;

-425,000 + 251,787 + 169,000 +3,500 + 28,000 + 69000

Net Present Value = 96,287