CSM Machine Shop is considering a four-year project to improve its production ef
ID: 2634791 • Letter: C
Question
CSM Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $490,000 is estimated to result in $189,000 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 $57,500. The press also requires an initial investment in spare parts inventory of $21,500, along with an additional $3,500 in inventory for each succeeding year of the project. The shop
CSM Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $490,000 is estimated to result in $189,000 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 $57,500. The press also requires an initial investment in spare parts inventory of $21,500, along with an additional $3,500 in inventory for each succeeding year of the project. The shop
Explanation / Answer
Hi,
First we need to calculate the cash inlows from year 1 to 4:
Annual pretax cost savings = $189000
Depreciation calculation
Cashflow for year 1 = (cost savings - depreciation)*(1-tax rate)+depreciation- working capital
=(189000-98000)*(1-35%)+98000-3500
=$153650
Cashflow for year 2: (cost savings - depreciation)*(1-tax rate)+depreciation- working capital
=(189000-156800)*(1-35%)+156800-3500
=$174230
Cashflow for year 3: (cost savings - depreciation)*(1-tax rate)+depreciation- working capital
=(189000-94080)*(1-35%)+94080-3500
=$152278
Cashflow for year 4:
Book Value = 490000-405328
=$84672
After taxsalvage value = 57500-((57500-84672)*35%)
=67010.2
(cost savings - depreciation)*(1-tax rate)+depreciation- working capital+recovery of working capital+after taxsalvage value
=(189000-56448)*(1-35%)+56448-3500+35500+67010.20
=$241617
Cash outflow = cost of machine + working capital
=490000+21500
=$511500
-----------------------
NPV:
Hence,the NPV of the project is $38837.36
year depreciation rate depreciation 1 20% 98000 2 32% 156800 3 19.20% 94080 4 11.52% 56448