Question

CSM Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $405,000 is estimated to result in $149,000 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 $50,000. The press also requires an initial investment in spare parts inventory of $15,500, along with an additional $2,500 in inventory for each succeeding year of the project. The shop’s tax rate is 25 percent and its discount rate is 12 percent. Calculate the project's NPV. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Calculation of working capital for each years
Year	0	1	2	3	4
Working capital	-$15,500	-$2,500	-$2,500	-$2,500	$23,000
Working capital invested from 0-3 would be recovered in year 4.
Calculation of net present value is shown below
Year	0	1	2	3	4
Cost savings before tax		$149,000	$149,000	$149,000	$149,000
Depreciation		-$81,000	-$129,600	-$77,760	-$46,656
Savings before tax		$68,000	$19,400	$71,240	$102,344
Taxes @ 25%		-$17,000	-$4,850	-$17,810	-$25,586
Net income		$51,000	$14,550	$53,430	$76,758
Add: Depreciation		$81,000	$129,600	$77,760	$46,656
Operating cash flow		$132,000	$144,150	$131,190	$123,414
Purchase of machine	-405000
Investment in working capital	-$15,500	-$2,500	-$2,500	-$2,500	$23,000
Aftertax salvage value					$54,996
Net cash flow	-$420,500	$129,500	$141,650	$128,690	$201,410
Discount factor @ 12%	1	0.89286	0.79719	0.71178	0.63552
Present value	-$420,500	$115,625	$112,923	$91,599	$128,000
Net present value	$27,646.21
Thus, project's NPV is $27,646.21
Calculation of depreciation based on MACRS
Year
1	405000*0.20	$81,000
2	405000*0.32	$129,600
3	405000*0.1920	$77,760
4	405000*0.1152	$46,656
Total		$335,016
Calculation of aftertax salvage value
Sale proceeds	$50,000
Less: Book value of machine	$69,984	(405000-335016)
Loss on sale of machine	-$19,984
Tax benefit @ 25%	$4,996
After tax salvage value	$54,996