Question

MACR

Year	​3-Year	​5-Year	​7-Year	​10-Year
1	​33.33%	​20.00%	​14.29%	​10.00%
2	​44.45%	​32.00%	​24.49%	​18.00%
3	​14.81%	​19.20%	​17.49%	​14.40%
4	​ 7.41%	​11.52%	​12.49%	​11.52%
5		​11.52%	​8.93%	​9.22%
6		​ 5.76%	​8.93%	​7.37%
7			​8.93%	​6.55%
8			​4.45%	​6.55%
9				​6.55%
10				​6.55%
11				​3.28%

Project cash flow and NPV.  The managers of Classic Autos Incorporated plan to manufacture classic Thunderbirds​ (1957 replicas). The necessary foundry equipment will cost a total of $3,900,000 and will be depreciated using a​ five-year MACRS​ life, Projected sales in annual units for the next five years are 310 per year. If the sales price is $26,000 per​ car, variable costs are $18000 per​ car, and fixed costs are $1300000 annually, what is the annual operating cash flow if the tax rate is 40​%? The equipment is sold for salvage for $500000 at the end of year five. What is the​ after-tax cash flow of the​ salvage? Net working capital increases by $600,000 at the beginning of the project​ (year 0) and is reduced back to its original level in the final year. What is the incremental cash flow of the​ project? Using a discount rate of 14 % for the​ project, determine whether the project should be accepted or rejected according to the NPV decision model.

​First, what is the annual operating cash flow of the project for year​ 1?

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-3900000
Initial working capital		-600000
=Initial Investment outlay		-4500000
5 years MACR rate			20.00%	32.00%	19.20%	11.52%	11.52%	5.76%
Unit sales			310	310	310	310	310
Profits	=no. of units sold * (sales price - variable cost)		2480000	2480000	2480000	2480000	2480000
Fixed cost			-1300000	-1300000	-1300000	-1300000	-1300000
-Depreciation	=Cost of machine*MACR%		-780000	-1248000	-748800	-449280	-449280	224640	=Salvage Value
=Pretax cash flows			400000	-68000	431200	730720	730720
-taxes	=(Pretax cash flows)*(1-tax)		240000	-40800	258720	438432	438432
+Depreciation			780000	1248000	748800	449280	449280
=after tax operating cash flow			1020000	1207200	1007520	887712	887712
reversal of working capital							600000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						300000
+Tax shield on salvage book value	=Salvage value * tax rate						89856
=Terminal year after tax cash flows							989856
Total Cash flow for the period		-4500000	1020000	1207200	1007520	887712	1877568
Discount factor=	(1+discount rate)^corresponding period	1	1.14	1.2996	1.481544	1.6889602	1.9254146
Discounted CF=	Cashflow/discount factor	-4500000	894736.8421	928901.2004	680047.302	525596.77	975149.98
NPV=	Sum of discounted CF=	-495567.90

after-tax cash flow of the​ salvage = 989856

Time line		0	1	2	3	4	5
Incremental Cash flow for the period		-4500000	1020000	1207200	1007520	887712	1877568

Reject project as NPV is negative