Question

Problem 11-12 New-Project Analysis Madison Manufacturing is considering a new machine that costs $350,000 and would reduce pre-tax manufacturing costs by $110,000 annually. Madison would use the 3-year MACRS method to depreciate the machine, and management thinks the machine would have a value of $33,000 at the end of its 5-year operating life. The applicable depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%. Working capital would increase by $35,000 initially, but it would be recovered at the end of the project's 5-year life. Madison's marginal tax rate is 40%, and a 11% cost of capital is appropriate for the project.

b. Assume management is unsure about the $110,000 cost savings - this figure could deviate by as much as plus or minus 20%.

Calculate the NPV if cost savings value deviate by plus 20%. Round your answer to the nearest dollar. $................

Calculate the NPV if cost savings value deviate by minus 20%. Round your answer to the nearest dollar. $.................

Answer 1

А В C E F G Н In Case cost savings value deviate by plus 20 % Solution- (A) $110000 20 %* $110000 $132,000 1 2 3 Years 0 1 2 3 4 4 Initial Investment ($350,000) 5working Capital Invested ($35,000) Cost Reduction $132,000 $132,000 $132,000 $132,000 $132,000 6 Less Dep $116,655 $155,575 $51,835 $25,935 7 $15,345 ($23,575) $80,165 $106,065 $132,000 Income 9 Tax Saving @40 % 10 Таx Expense $0 ($9,430) $6,138 $32,066 $42,426 $52,800 11 Income After Tax $9,207 ($14,145) $48,099 $63,639 $79,200 12 Add- Dep $116,655 $155,575 $51,835 $25,935 13 Cash Flow $125,862 $141,430 $99,934 $89,574 $79,200 14 Working Capital $35,000 After tax Salvage Value $19,800 15 16 Net Cash flow ($385,000) $125,862 $141,430 $99,934 $89,574 $134,000 $1 $1 $1 $1 $1 17 PVF @ 11 % 1.00 $113,389 ($385,000) $127,414 $90,031 $80,697 $120,721 18 PV 19 NPV Sum of PV of Cashflows $147,252 20 21 Year 1 2 7.41% 22 Dep rate 33.33% 44.45% 14.81% 23 Machine Cost 350,000.00 350,000.00 350,000.00 350,000.00 24 Dep Expense 116,655.00 155,575.00 51,835.00 25,935.00 25 Salvage Val ue 26 Tax on Salvage $33,000 40%*33000 $13,200 $19,800 27

foix L8 А В C E F G Н Solution- (A) $110000 20%*$110000 In Case cost savings value deviate by minus 20% $88,000 1 2 3 Years 0 1 2 4 4 Initial Investment ($350,000) 5working Capital Invested ($35,000) 6 Cost Reduction $88,000 $88,000 $88,000 $88,000 $88,000 Less Dep $116,655 $155,575 $51,835 $25,935 7 8 Income 9 Tax Saving @40 % ($28,655) ($67,575) $36,165 $62,065 $88,000 ($11,462) ($27,030) 10 Тax Expense $0 $14,466 $24,826 $35,200 ($17,193) 11 Income After Tax ($40,545) $21,699 $37,239 $52,800 12 Add - Dep $116,655 $155,575 $51,835 $25,935 $0 13 Cash Flow $99,462 $115,030 $73,534 $63,174 $52,800 14 Working Capital $35,000 After tax Salvage Value $19,800 15 $107,600 16 Net Cash flow ($385,000) $99,462 $115,030 $73,534 $63,174 $1 $1 $1 $1 $1 17 PVF @ 11 % 1.00 $96,937 ($385,000) $89,605 $28,333 $103,631 $66,247 $56,914 18 PV 19 NPV Sum of PV of Cashflows 20 21 Year 1 2 7.419% 22 Dep rate 33.33% 44.45% 14.81% 350,000.00 350,000.00 23 Machine Cost 350,000.00 350,000.00 24 Dep Expense 116,655.00 155,575.00 51,835.00 25,935.00 25 Salvage Value 26 Tax on Salvage $33,000 40%*33000 $13,200 $19,800 27