Question

Starset Machine Shop is considering a 4-year project to improve its production efficiency. Buying a new machine press for $455,000 is estimated to result in $187,000 in annual pretax cost savings. The press falls in the 5-year MACRS class, and it will have a salvage value at the end of the project of $75,000. The press also requires an initial investment in spare parts inventory of $34,000, along with an additional $3,800 in inventory for each succeeding year of the project. The shop’s tax rate is 24 percent and its discount rate is 9 percent. (MACRS schedule)

NPV:

Calculate the NPV of this project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Should the company buy and install the machine press?

a. Yes
b. No

Answer 1

Answer:

NPV: $11,238

a. Yes

Explanation:

Total Investment (PV) = a new machine press for $455,000 + initial investment in spare parts inventory of $34,000 = $489000

Pretax cost saving $187,000 -> After tax saving = $187,000 * (1- tax rate 24%)= $142,120  

Cash flow of every year = After tax saving $142,120 - additional $3,800 in inventory for each succeeding year = $138,320

a salvage value at the end of the project of $75,000 is in year 5 => Cash flow of year 5 = $138,320  + $75,000 = $213,320

• Discount rate: 9%
• Cash flow year 1: - 489,000

• Cash flow year 2:  138,320

• Cash flow year 3:  138,320

• Cash flow year 4:  138,320

• Cash flow year 5:  213,320

We use excel to calculate the Net Present Value of Project

= NPB(rate, cash flow of year 1 - year 5)

= NPV(9%, -489000,138320, 138,320, 138,320 , 213,320)

= $11,238

Yes, the company should buy and install the machine because NPV is positive

(Please see excel calculation attached)