Thornley Machines is considering a 3-year project with an initial cost of $660,0

Question

Thornley Machines is considering a 3-year project with an initial cost of $660,000. The project will not directly produce any sales but will reduce operating costs by $400,000 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 $72,000. The tax rate is 34 percent. The project will require $16,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 12 percent? Why or why not?

Explanation / Answer

Calculation of NPV of the Project:

Net PV = PV of Inflow - Outflow

NPV = $561,787 - $676,000

NPV = $- 114,213

So, this Project should not be implimented because the NPV of saving is less than the cost involved in the Project.

0 1 2 3 Outflow 660,000 Inventories 16,000 Inflow 400,000 400,000 400,000 Less: Dep. 220,000 220,000 220,000 Inflow Before Tax 180,000 180,000 180,000 Less: Tax(34%) 61,200 61,200 61,200 Inflow After Tax 118,800 118,800 118,800 Add: Depreciation 220,000 220,000 220,000 Add: After tax Salvage Value 47,520 DF(12%) 0.892 0.797 0.711 PV of Inflow 196,240 175,340 190,207 Total PV of Inflow 561,787

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