Massey Machine Shop is considering a four-year project to improve its production
ID: 2768182 • Letter: M
Question
Massey Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $520,000 is estimated to result in $215,000 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 $87,000. The press also requires an initial investment in spare parts inventory of $25,000, along with an additional $3,000 in inventory for each succeeding year of the project. The shop’s tax rate is 34 percent and its discount rate is 10 percent. Refer to the MACRS schedule.
Calculate the NPV of this project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Massey Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $520,000 is estimated to result in $215,000 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 $87,000. The press also requires an initial investment in spare parts inventory of $25,000, along with an additional $3,000 in inventory for each succeeding year of the project. The shop’s tax rate is 34 percent and its discount rate is 10 percent. Refer to the MACRS schedule.
Explanation / Answer
Calculation of NPV of the project:
Year 0
Year 1
Year 2
Year 3
Year 4
Cost of the Machine (A)
$ (520,000.00)
Annual after-tax cost savings (215000*(1-34%) (B)
$ 141,900.00
$ 141,900.00
$ 141,900.00
$ 141,900.00
Tax Saving on Depreciation :
MACRS five-year class Depreciation rate
20.00%
32.00%
19.20%
11.52%
Depreciation = 520000*Dep. Rate
$ 104,000.00
$ 166,400.00
$ 99,840.00
$ 59,904.00
Tax Saving = Depreciation * 34% (C)
$ 35,360.00
$ 56,576.00
$ 33,945.60
$ 20,367.36
Salvage value at the end of the project (D)
$ 87,000.00
Tax on Capital Gain on Sale of Machine:
Book Value = 520000*(11.52+5.76)% = 89856
Loss on Sale = 89856 - 87000 = 2856
Tax Saving on loss = 2856 * 34% = 971.04 (E)
$ 971.04
Initial investment in spare parts inventory (F)
$ (25,000.00)
Investment in inventory (G)
$ (3,000.00)
$ (3,000.00)
$ (3,000.00)
$ (3,000.00)
Net Cash Flows (A+B+C+D+E+F+G)
$ (545,000.00)
$ 174,260.00
$ 195,476.00
$ 172,845.60
$ 247,238.40
PVF (10%)
1
0.90909
0.82645
0.75131
0.68301
1/(1+10%)^0
1/(1+10%)^1
1/(1+10%)^2
1/(1+10%)^3
1/(1+10%)^4
PV = CF * PVF =
$ (545,000.00)
$ 158,418.02
$ 161,551.14
$ 129,860.63
$ 168,866.30
NPV = Sum of PVs
$ 73,696.09
Calculation of NPV of the project:
Year 0
Year 1
Year 2
Year 3
Year 4
Cost of the Machine (A)
$ (520,000.00)
Annual after-tax cost savings (215000*(1-34%) (B)
$ 141,900.00
$ 141,900.00
$ 141,900.00
$ 141,900.00
Tax Saving on Depreciation :
MACRS five-year class Depreciation rate
20.00%
32.00%
19.20%
11.52%
Depreciation = 520000*Dep. Rate
$ 104,000.00
$ 166,400.00
$ 99,840.00
$ 59,904.00
Tax Saving = Depreciation * 34% (C)
$ 35,360.00
$ 56,576.00
$ 33,945.60
$ 20,367.36
Salvage value at the end of the project (D)
$ 87,000.00
Tax on Capital Gain on Sale of Machine:
Book Value = 520000*(11.52+5.76)% = 89856
Loss on Sale = 89856 - 87000 = 2856
Tax Saving on loss = 2856 * 34% = 971.04 (E)
$ 971.04
Initial investment in spare parts inventory (F)
$ (25,000.00)
Investment in inventory (G)
$ (3,000.00)
$ (3,000.00)
$ (3,000.00)
$ (3,000.00)
Net Cash Flows (A+B+C+D+E+F+G)
$ (545,000.00)
$ 174,260.00
$ 195,476.00
$ 172,845.60
$ 247,238.40
PVF (10%)
1
0.90909
0.82645
0.75131
0.68301
1/(1+10%)^0
1/(1+10%)^1
1/(1+10%)^2
1/(1+10%)^3
1/(1+10%)^4
PV = CF * PVF =
$ (545,000.00)
$ 158,418.02
$ 161,551.14
$ 129,860.63
$ 168,866.30
NPV = Sum of PVs
$ 73,696.09