Purple Haze Machine Shop is considering a four-year project to improve its produ
ID: 2614135 • Letter: P
Question
Purple Haze Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $530,000 is estimated to result in $220,000 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 $89,000. The press also requires an initial investment in spare parts inventory of $26,000, along with an additional $3,100 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and its discount rate is 9 percent. Refer to Table 10.7.
Calculate the NPV of this project. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Should the company buy and install the machine press?
Purple Haze Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $530,000 is estimated to result in $220,000 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 $89,000. The press also requires an initial investment in spare parts inventory of $26,000, along with an additional $3,100 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and its discount rate is 9 percent. Refer to Table 10.7.
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 5.76Explanation / Answer
Year 0:
Initial Investment = $530,000
Investment in NWC = $26,000
Net Cash Flow = Initial Investment + Investment in NWC
Net Cash Flow = -$530,000 - $26,000
Net Cash Flow = -$556,000
Year 1:
Depreciation = $530,000 * 20.00%
Depreciation = $106,000
Pretax Cost Saving = $220,000
OCF = Pretax Cost Saving * (1 - tax) + tax * Depreciation
OCF = $220,000 * (1 - 0.35) + 0.35 * $106,000
OCF = $180,100
Net Cash Flow = OCF - Additional Investment in NWC
Net Cash Flow = $180,100 - $3,100
Net Cash Flow = $177,000
Year 2:
Depreciation = $530,000 * 32.00%
Depreciation = $169,600
Pretax Cost Saving = $220,000
OCF = Pretax Cost Saving * (1 - tax) + tax * Depreciation
OCF = $220,000 * (1 - 0.35) + 0.35 * $169,600
OCF = $202,360
Net Cash Flow = OCF - Additional Investment in NWC
Net Cash Flow = $202,360 - $3,100
Net Cash Flow = $199,260
Year 3:
Depreciation = $530,000 * 19.20%
Depreciation = $101,760
Pretax Cost Saving = $220,000
OCF = Pretax Cost Saving * (1 - tax) + tax * Depreciation
OCF = $220,000 * (1 - 0.35) + 0.35 * $101,760
OCF = $178,616
Net Cash Flow = OCF - Additional Investment in NWC
Net Cash Flow = $178,616 - $3,100
Net Cash Flow = $175,516
Year 4:
Depreciation = $530,000 * 11.52%
Depreciation = $61,056
Pretax Cost Saving = $220,000
OCF = Pretax Cost Saving * (1 - tax) + tax * Depreciation
OCF = $220,000 * (1 - 0.35) + 0.35 * $61,056
OCF = $164,369.60
Book Value at the end of Year 4 = $530,000 - $106,000 - $169,600 - $101,760 - $61,056
Book Value at the end of Year 4 = $91,584
After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax
After-tax Salvage Value = $89,000 - ($89,000 - $91,584) * 0.35
After-tax Salvage Value = $89,904.40
Net Cash Flow = OCF + Investment in NWC recovered + After-tax Salvage Value
Net Cash Flow = $164,369.60 + $35,300 + $89,904.40
Net Cash Flow = $289,574
NPV = -$556,000 + $177,000/1.09 + $199,260/1.09^2 + $175,516/1.09^3 + $289,574/1.09^4
NPV = $114,770.55
So, NPV of this project is $114,770.55
So, the company should buy and install this machine press.
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