CSM Machine Shop is considering a four-year project to improve its production ef
ID: 2755324 • Letter: C
Question
CSM Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $494,000 is estimated to result in $193,000 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 $59,500. The press also requires an initial investment in spare parts inventory of $21,900, along with an additional $3,900 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and its discount rate is 11 percent.
Calculate the NPV. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
CSM Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $494,000 is estimated to result in $193,000 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 $59,500. The press also requires an initial investment in spare parts inventory of $21,900, along with an additional $3,900 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and its discount rate is 11 percent.
Explanation / Answer
Working notes:
(1) MACRS Depreciation Schedule
MACRS Schedule source: http://www.smbiz.com/sbrl012.html
(2) Initial cost, year 0 = $(494,000 + 21,900) = $515,900
(3) Earning Before Tax, EBT = Pre-tax cost savings - Annual Depreciation
(4) Earning After Tax, EAT = EBT x (1 - Tax rate) = EBT x 0.65
(5) Cash Flow After Tax, CFAT = Initial Investment + EAT + Annual Depreciation** - Working Capital
**Depreciation being non-cash expense, is added back to EAT to obtain CFAT
(5) Year-5 Annual pre-tax cost saving will be increased by $59,500 (Salvage Value)
(6) NPV = sum of all cash inflows & outflows discounted at 11%
Accordingly, NPV is computed as follows.
Year Depreciation Base ($) Depreciation % Annual Depreciation ($) = Depreciation Base x Depreciation (%) 1 4,94,000 20 98,800 2 4,94,000 32 1,58,080 3 4,94,000 19.2 94,848 4 4,94,000 11.52 56,909 5 4,94,000 11.52 56,909