Purple Haze Machine Shop is considering a four-year project to improve its produ

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

Explanation / Answer

First, we will calculate the depreciation each year, which will be:

D1= $530,000(0.2000) = $106,000

D2= $530,000(0.3200) = $169,600

D3= $530,000(0.1920) = $101,760

D4= $530,000(0.1152) = $61,056

The book value of the equipment at the end of the project is:

BV4= $530,000 ? ($106,000 + 169,600 + 101,760 + 61,056) = $91,584

The asset is sold at a loss to book value, so this creates a tax refund.

After tax salvage value = $89,000 + ($91,584 ? 89,000)(0.35) = $88,095.6

So, the OCF for each year will be:

OCF1 = $220,000(1 ? 0.35) + 0.35($106,000) = $180,100

OCF2= $220,000(1 ? 0.35) + 0.35($169,600) = $202,360

OCF3= $220,000(1 ? 0.35) + 0.35($101,760) = $178,616

OCF4= $220,000(1 ? 0.35) + 0.35($61,056) = $164,369.6

The project requires $26,000 of NWC at the beginning, and $3,100 more in NWC each successive year. We will subtract the $26,000 from the initial cash

Year OCF Investment NWC Salvage value Cash flow PVF PVCF 0 (530000) (26000) (556000) 1 -556000 1 180100 (3100) 177000 0.917431 162385.3 2 202360 (3100) 199260 0.84168 167713.2 3 178616 (3100) 175516 0.772183 135530.6 4 164370 35300 88096 287766 0.708425 203860.7 Net Present Value 113489.7

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