Starset Machine is considering a 4-year project to improve its production efficiency. Buying a new machine press for $470,000 is estimated to generate $196,000 in annual pretax  cost savings. The press falls in 5-year MACRS class and will salvage value of $72,000 at the end of the project. The press also require an initial investment in spare part inventory of $37,000, along with additional $3,950 in inventory for each succeeding year of the project. Starset tax rate is 22% and the discount rate is 11%.a) Calculate the NPV of this project?b) Should the company buy or invest in this project? Yes or No?

Question
Asked Mar 6, 2019

Starset Machine is considering a 4-year project to improve its production efficiency. Buying a new machine press for $470,000 is estimated to generate $196,000 in annual pretax  cost savings. The press falls in 5-year MACRS class and will salvage value of $72,000 at the end of the project. The press also require an initial investment in spare part inventory of $37,000, along with additional $3,950 in inventory for each succeeding year of the project. Starset tax rate is 22% and the discount rate is 11%.

a) Calculate the NPV of this project?

b) Should the company buy or invest in this project? Yes or No?

check_circleExpert Solution
Step 1

5 Year MACRS depreciation scheudle has been mapped below. Based on total depreciation, we have calculated the post tax salavage value. Please see the table below. The column titled "Linkage" will helpyou understand how each value has been calculated.

Cost of machine press

470,000

   

Year

1

2

3

4

5 Year MACRS depreciation schedule

20%

32%

19.20%

11.52%

Depreciation

94,000

150,400

90,240

54,144

     

Book value of asset

470,000

A

  

[-] Total Depreciation in 4 years

388,784

B

  

Remaining book value after 4 years

81,216

C = A - B

  

Salvage Value after 4 years

72,000

D

  

Gain / (Loss) on sale of asset

(9,216)

E = D - C

  

Tax rate

22%

F

  

Tax on gain / (Loss)

(2,028)

G = E x F

  

Post tax salvage value

74,028

H = D - G

  
Step 2

Year, N

Linkage

0

1

2

3

4

Capital expenditure

A

(470,000)

    

Post tax salvage value

B

    

74,028

Investment in working capital

C

(37,000)

(3,950)

(3,950)

(3,950)

48,850

       

Annual pretax  cost savings

D

 

196,000

196,000

196,000

196,000

[-] Depreciation

E

 

(94,000)

(150,400)

(90,240)

(54,144)

Pre tax incremental profits

F = D + E

 

102,000

45,600

105,760

141,856

[-] Taxes

G = -22% x F

 

(22,440)

(10,032)

(23,267)

(31,208)

NOPAT

H = F + G

 

79,560

35,568

82,493

110,648

[+] Depreciation

E

 

94,000

150,400

90,240

54,144

Annual operating cash flows

I = H + E

 

173,560

185,968

172,733

164,792

       

Net Cash flows

A + B + C + I

(507,000)

169,610

182,018

168,783

287,669

Step 3

Part (a)

Discount rate , R = 11%

Disocunt factor for yrar N = (1 + R)-N = (1 + 11%)-N = 1.11-N 

PV of cash flow = Net cash flows x Discount factor

NPV = Sum of PV of all the cash flows.

Please see the table below:

Year, N

Linkage

0

1

2

3

4

Net Cash flows

A + B + C + I

(507,000)

169,610

182,018

168,783

287,669

Discount factor

 

1.0000

0.9009

0.8116

0.7312

0.6587

PV of cash flows

 

(507,000)

152,802

147,730

123,413

189,497

NPV

 

106,441

    
...

Want to see the full answer?

See Solution

Check out a sample Q&A here.

Want to see this answer and more?

Solutions are written by subject experts who are available 24/7. Questions are typically answered within 1 hour*

See Solution
*Response times may vary by subject and question
Tagged in

Business

Finance

Related Finance Q&A

Find answers to questions asked by student like you

Show more Q&A add
question_answer

Q: Mexican Motor's market cap is 200 billion pesos. Next year's cash flow is 8.6 billion pesos. Securit...

A: Mexican Motor's market cap, E = 200 billion pesos.Next year's cash flow, C =  8.6 billion pesos.Secu...

question_answer

Q: if A firm's current balance sheet is as follows: Assets                      $100                   ...

A: Click to see the answer

question_answer

Q: Calculate the future value after 3 years if $1,000 is deposited at 1.2% interest compounded monthly.

A: Calculate the future value after 3 years if $1,000 is deposited at 1.2% interest compounded monthly....

question_answer

Q: Your firm has a​ risk-free investment opportunity with an initial investment of $162,000 today and r...

A: Calculation of Interest Rate of the Project:The Interest Rate of the Project can be calculated using...

question_answer

Q: A stock has a beta of 1.14 and an expected return of 10.5 percent. A risk-free asset currently earns...

A: Calculating the expected return on a portfolio that is equally invested in the two assets. We have,E...

question_answer

Q: Capital budgeting problems  and what king of you used for solving (NPV and IRR PROBLEMS ) A firm has...

A: All the financials in this solution are in $. Figures in parenthesis mean negative values.Based on t...

question_answer

Q: A 25-year annuity was purchased with $225,000 that had accumulated in a RRSP.  The annuity provides ...

A: This question is based solved using Excel functions:PMT: Tells us monthly mortgage payment on a loan...

question_answer

Q: Suppose that, in each period, the cost of a security either goes up by a factor of 2 or goes down by...

A: We have two options here, first is doubling and second is moving down by half. We assume that the pr...

question_answer

Q: For example, assume Ethan wants to earn a return of 7.00% and is offered the opportunity to purchase...

A: Calculating the intrinsic value of the bond. We have,Intrinsic value = A / (1+C)1 + A / (1+C)2 + A /...