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?
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 |
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 |
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 |
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