Massey Machine Shop is considering a four-year project to improve its production
ID: 2741355 • Letter: M
Question
Massey Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $530,000 is estimated to result in $220,000 in annual pretax cost savings. The press falls in the MACRS five-year class, and it will have a salvage value at the end of the project of $89,000. The press also requires an initial investment in spare parts inventory of $26,000, along with an additional $3,100 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and its discount rate is 9 percent. Refer to table 6.8
Table 6.8
Property Class
Year Three-Year Five-Year Seven-Year
1 33.33% 20.00% 14.29%
2 44.45% 32.00% 24.49%
3 14.81% 19.20% 17.49%
4 7.41% 11.52% 12.49%
5 11.52% 8.93%
6 5.76% 8.92%
7 8.93%
8 4.46%
Calculate the NPV of this project. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Explanation / Answer
Project Life=4 years
Machine Cost= $530000
Salvage Value= $89000
Initial Project Cost= Machine Cost + Investment in Spare Parts
= $ 530000+ $ 26000 =$ 556000
Annual Pre Tax Cost Saving= $ 220000
Present Value of Post Tax Cost Saving= $ (220000-3100) * 65%*PVAF,9%,4years
=$ 216900*65%*3.24 {refer PVAF Table}/ you can also compute by this formula={1-(1+r)-n}/r, where r=rate,n=no. of years
=$ 456791
Tax Saving through depreciation
year Depreciation Amount-MACR Tax Saving PVF @ 9% PRESENT VALUE
1 $530000*20%=106000 106000*35%=37100 .92 =37100* 0.92= 33761
2 $530000*32%=169600 169600*35%=59360 .84 =59360*0.84= 49862
3 $530000*19.20%=101760 101760*35%=35616 .77 =35616 * 0.77=27424
4 $530000*11.52%=61056 61056*35%=21370 .71 =21370 * .71 =15173
Total Savings 126220
Salvage Value=89000 * PVAF,9%,4TH YEAR= $63190
So, Total Present Value of Savings= Present Value of Net Annual Cost Savings + Tax saving thru Depreciation + Present Value of Scrap =$ 456791+ $126220 + $63190 = $ 646201
Net Present Value = Present Value of Saving- Initial Project Cost = $ 646201.40- $ 556000 = $ 90201.40
Since The NPV is Positive so the Project can be accepted.