Question

please use excel to answer the question and show all outputs

E2) Singler Manufacturing is considering a new machine that costs $250,000. The machine would reduce pretax manufacturing costs by $90,000 annually. The machine falls in the 3-year MACRS class for depreciation, and management estimates a salvage value of $23,000 at the end of 5 years of operation. The machine will cause a one-time increase of net operating working Sudha Krishnaswami Lecture Notes Page 1 of 2 Homework 4 capital of $25,000 initially, which would be recovered at the end of the machine's 5-year life. Singler's marginal tax rate is 40% and its WACC is 10%. Should the firm invest in the new machine? Suppose management is unsure about the pretax manufacturing cost savings, what is the minimum cost savings the machine should generate in order to break even?

Answer 1

Part-a)

Depreciation Calculation:

Year	Deprecaition Rate as per MACRS	Cost of New Machine	Depreciation	Tax Sheild (Depn*40%)
1	33.33%	250,000	83,325	33,330
2	44.45%	250,000	111,125	44,450
3	14.81%	250,000	37,025	14,810
4	7.41%	250,000	18,525	7,410

.

Profit on sale of machine at the end of project (i.e. at the end of 5 years) =Sales Value – Book Value

= 23,000 – 0

= $23,000

After Tax Salvage value on sale of machine at the end of project (i.e. at the end of 5 years) = 23,000 – (23,000*40%)

= $13,800

.

After Tax Savings in Manufacturing Cost = Pretax Savings in Manufacturing Cost *(1-Tax Rate)

= 90,000*(1-0.40)

= 90,000*0.60

= $54,000

.

Note:

Annual Savings After Tax = After Tax Savings in Manufacturing Cost + Depreciation Tax Sheild.

.

Calculation of NPV:

Year	Initial Investment	Working Capital	Salvage Value	Depn Tax Sheild (a)	After Tax Savings in Manufacturing Cost (b)	Annual Savings After Tax = (a) + (b )	Cash Flows Working	Cash Flows (c )	DF Working	Discounting Factor (d)	Present Value = (c )*(d)
0	(250,000)	(25,000)		-	-	-	(250,000)+(25,000)	(275,000)	1	1	(275,000.00)
1	-	-		33,330	54,000	87,330	87,330	87,330	1/1.10^1	0.909090909	79,390.91
2	-	-		44,450	54,000	98,450	98,450	98,450	1/1.10^2	0.826446281	81,363.64
3	-	-		14,810	54,000	68,810	68,810	68,810	1/1.10^3	0.751314801	51,697.97
4	-	-		7,410	54,000	61,410	61,410	61,410	1/1.10^4	0.683013455	41,943.86
5	-	25,000	13800	-	54,000	54,000	(25,000+13,800+54,000)	92,800	1/1.10^5	0.620921323	57,621.50
										NPV:	37,017.87

Conclusion:

Yes , the firm should invest in the Machine , since its NPV is positive.

.

Part-b)

Let , Minimum cost savings the machine should generate be "$x"

Therefore,

After Tax Savings in Manufacturing Cost = Pretax Savings in Manufacturing Cost *(1-Tax Rate)

= x*(1-0.40)

=0.6x

.

Working:

Year	Initial Investment	Working Capital	Salvage Value	Depn Tax Sheild (a)	After Tax Savings in Manufacturing Cost (b)	Annual Savings After Tax = (a) + (b )	Cash Flows Working	Cash Flows (c )	DF Working	Discounting Factor (d)	Present Value = (c )*(d)
0	(250,000)	(25,000)		-	-	-	(250,000)+(25,000)	(275,000)	1	1	(275,000.00)
1	-	-		33,330	0.6x	0.6x+33,330	0.6x+33,330	0.6x+33,330	1/1.10^1	0.909090909	0.5455x+30,300
2	-	-		44,450	0.6x	06x+44,450	06x+44,450	06x+44,450	1/1.10^2	0.826446281	0.4959x+36735.54
3	-	-		14,810	0.6x	0.6x+14,810	0.6x+14,810	0.6x+14,810	1/1.10^3	0.751314801	0.4508x+11126.97
4	-	-		7,410	0.6x	0.6x+7,410	0.6x+7,410	0.6x+7,410	1/1.10^4	0.683013455	0.4098+5061.13
5	-	25,000	13800	-	0.6x	0.6x	(25,000+13,800+0.6x)	0.6x+38,800	1/1.10^5	0.620921323	0.3726x+24091.75
										NPV:	2.2745x -167684.61

At break even , NPV is zero.

Therefore,

2.2745x -167,684.61 = 0

2.2745x = 167,684.61

x = 167,684.61/2.2745

x = 73,724.63

.

.

So the answer is $73.724.63

.