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Warmack Machine Shop is considering a four-year project to improve its productio

ID: 2475153 • Letter: W

Question

Warmack Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $500,000 is estimated to result in $205,000 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 $84,000. The press also requires an initial investment in spare parts inventory of $23,000, along with an additional $2,800 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and its discount rate is 9 percent. MACRS schedule

Calculate the NPV of this project.

Warmack Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $500,000 is estimated to result in $205,000 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 $84,000. The press also requires an initial investment in spare parts inventory of $23,000, along with an additional $2,800 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and its discount rate is 9 percent. MACRS schedule

Property Class Year Three-Year 33.33% 44.45 14.81 7.41 Seven-Year 14.29% 24.49 17.49 12.49 8.93 8.92 8.93 4.46 Five-Year 2 3 4 5 6 7 20.00% 32.00 19.20 11.52 11.52 5.76

Explanation / Answer

Warmack Machine Shops Assuming NWC in spares is returned after   project. Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 MACRS Rates 20.00% 32.00% 19.20% 11.52%                 11.52                    5.76 Machine cost        500,000.00 Book Value after 4 years          86,400.00 Resale value            84,000.00 Capital Loss            2,400.00 Tax Benefit on Capital Loss @35%                840.00 NPV Calculation Year 0 Year 1 Year 2 Year 3 Year 4 Investment in Press=           (500,000) Investment in NWC for spares              (23,000)            (2,800)              (2,800)            (2,800)            (2,800) Return of NWC            34,200 Salvage              84,000 Net Pretax Cost Saving          205,000           205,000         205,000         205,000 Less Depreciation          (100,000)         (160,000)         (96,000)         (57,600) Pre Tax Saving            105,000              45,000         109,000         147,400 Tax @35%          (36,750)           (15,750)         (38,150)         (51,590) Tax benefit on Capital Loss                  840 Post Tax Income            68,250              29,250            70,850            96,650 Add Back Depreciation          100,000           160,000            96,000            57,600 Net Cash Flow(including salvage +NWC)           (523,000)          165,450           186,450         164,050         269,650 PV Factor @9%                           1               0.917                0.842              0.772              0.708 PV of Cash flows     (523,000.00)    151,788.99     156,931.23 126,676.70 191,026.86 NPV = Sum of PV of cash flows= $   103,423.78