Thornley Machines is considering a 3-year project with an initial cost of $810,0

Question

Thornley Machines is considering a 3-year project with an initial cost of $810,000. The project will not directly produce any sales but will reduce operating costs by $430,000 a year. The equipment is depreciated straight-line to a zero book value over the life of the project. At the end of the project the equipment will be sold for an estimated $87,000. The tax rate is 34 percent. The project will require $21,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 9 percent? Why or why not?

Explanation / Answer

Hi,

Please find the detailed answer as follows:

NPV = -831000 + 344587.16 + 3,16,135.01 + 3,50,586.74 = $180308.91 or $180309

Yes, the project should be accepted as it offers a + NPV. of $180308.91 or $180309.

Thanks.

Particulars 0 1 2 3 Initial Investment $(8,10,000.00) Introduction of Working Capital $(21,000.00) Savings in Operating Costs $4,30,000.00 $4,30,000.00 $4,30,000.00 Depreciation $(2,70,000.00) $(2,70,000.00) $(2,70,000.00) Profit before tax $1,60,000.00 $1,60,000.00 $1,60,000.00 Taxes @ 34% $(54,400.00) $(54,400.00) $(54,400.00) Profit after tax $1,05,600.00 $1,05,600.00 $1,05,600.00 Depreciation $2,70,000.00 $2,70,000.00 $2,70,000.00 Recovery of Working Capital $21,000.00 Salvage Value (net of tax) $57,420.00 Net Cash Flows $(8,31,000.00) $3,75,600.00 $3,75,600.00 $4,54,020.00 PVF @ 9% 1.000 0.917 0.842 0.772 Present Value $(8,31,000.00) $3,44,587.16 $3,16,135.01 $3,50,586.74

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