CSM Machine Shop is considering a four-year project to improve its production ef
ID: 2729975 • Letter: C
Question
CSM Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $497,000 is estimated to result in $196,000 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 $61,000. The press also requires an initial investment in spare parts inventory of $22,200, along with an additional $4,200 in inventory for each succeeding year of the project. The shop’s tax rate is 34 percent and its discount rate is 12 percent.
Calculate the NPV.
Explanation / Answer
CSM Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $497,000 is estimated to result in $196,000 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 $61,000. The press also requires an initial investment in spare parts inventory of $22,200, along with an additional $4,200 in inventory for each succeeding year of the project. The shop’s tax rate is 34 percent and its discount rate is 12 percent.
Calculate the NPV.
First we need to compute annual depreciation:
Depreciation Schedule:
Year
Depreciation basis
MACRS rate
Depreciation
1
497000
20%
99400
2
497000
32%
159040
3
497000
19.20%
95424
4
497000
11.52%
57254.4
411118.4
Book value of asset at the end of the project = cost – total depreciation
= 497,000 -411,118.40
= 85881.60
Net salvage value = salvage value – (salvage value – book value)x tax rate
= 61,000 – (61,000-85881.60) x 0.34
= 61,000 + 8459.74
= 69,459.74
Cash flows
Year
0
1
2
3
4
Cost of asset
-497000
cost saving
190000
190000
190000
190000
(-) Depreciation
-99400
-159040
-95424
-57254.4
Income before taxes
90600
30960
94576
132745.6
(-) Taxes 34%
-30804
-10526.4
-32155.8
-45133.5
Depreciation
99400
159040
95424
57254.4
working capital required
-22200
-4200
-4200
-4200
34800
Net salvage value
69459.74
Cash flows
-519200
154996
175273.6
153644.2
249126.2
Calculation for NPV
NPV is the sum of present value of all cash flows discounted at the given discount rate.
Year
Cash flow
PV factor 12%
PV
0
-519200.00
1.0000
-519200
1
154996.00
0.8929
138389.2857
2
175273.60
0.7972
139727.0408
3
153644.16
0.7118
109360.8783
4
249126.24
0.6355
158324.2268
NPV
26601.43
Therefore, NPV would be 26,601.43.
Year
Depreciation basis
MACRS rate
Depreciation
1
497000
20%
99400
2
497000
32%
159040
3
497000
19.20%
95424
4
497000
11.52%
57254.4
411118.4