Geary Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $547,200 is estimated to result in $182,400 in annual pretax cost savings. The press falls in the MACRS five-year class (MACRS Table), and it will have a salvage value at the end of the project of $79,800. The press also requires an initial investment in spare parts inventory of $22,800, along with an additional $3,420 in inventory for each succeeding year of the project. |
Required : |
If the shop's tax rate is 32 percent and its discount rate is 13 percent, what is the NPV for this project? (Do not round your intermediate calculations.) |
Step 1 calculate the depreciation schedule:
Depreciation Schedule as Per MACRS 5 year rates | ||||
Year | Opening Balance | Investment | Depreciation | Closing Balance |
0 | 547200 | 547200 | ||
1 | 547200 | 0.2*547200=109440 | 437760 | |
2 | 437760 | 0.32*547200=175104 | 262656 | |
3 | 262656 | 0.192*547200=105062.4 | 157593.6 | |
4 | 157593.6 | 0.1152*547200=63037.44 | 94556.16 | |
5 | 94556.16 | 0.1152*547200=63037.44 | 31518.72 | |
6 | 31518.72 | 0.0576*547200=31518.72 | 0 |
Step 2 CF schdule and NPV calculation:
CF schedule | ||||||
Year | Remark | 0 | 1 | 2 | 3 | 4 |
Pretax savings | Given | 182400 | 182400 | 182400 | 182400 | |
Depreciation | Calculated above | 109440 | 175104 | 105062.4 | 63037.44 | |
EBIT | Pretax savings-Depreciation | 72960 | 7296 | 77337.6 | 119362.56 | |
Tax | 32% x EBIT | 23347.2 | 2334.72 | 24748.032 | 38196.0192 | |
EAT | EBIT-Tax | 49612.8 | 4961.28 | 52589.568 | 81166.5408 | |
Depreciation | Added back as non cash expense | 109440 | 175104 | 105062.4 | 63037.44 | |
Initial investment | Given | -547200 | ||||
WCINV | Given | -22800 | -3420 | -3420 | -3420 | -3420 |
WCINV Recovery | As per convention | 36480 | ||||
Salvage Value | Given | 79800 | ||||
Tax on profit | 32% x (salvage value-book value at the end of year 4) | -4426.848 | ||||
CF | EAT+Depreciation+Investment+WCINV+WCINV recovery+Salvage value+Tax on profit | -570000 | 155632.8 | 176645.28 | 154231.968 | 252637.1328 |
Discount factor formula | 1/1.13^0 | 1/1.13^1 | 1/1.13^2 | 1/1.13^3 | 1/1.13^4 | |
Discount factor | 1 | 0.884955752 | 0.783146683 | 0.693050162 | 0.613318728 | |
DCF | CF x Discount factor | -570000 | 137728.1416 | 138339.1652 | 106890.4905 | 154947.0849 |
NPV = Sum of all Discounted CF | -32095.11794 |
NPV = -32095.12, as it is negative, the project is not worth investing.
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