  # 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

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.

 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

#### 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 