A proposed cost-saving device has an installed cost of $640,000. The device will
ID: 2644254 • Letter: A
Question
A proposed cost-saving device has an installed cost of $640,000. The device will be used in a five-year project but is classified as three-year MACRS property for tax purposes. The required initial net working capital investment is $55,000, the marginal tax rate is 35 percent, and the project discount rate is 12 percent. The device has an estimated Year 5 salvage value of $60,000. What level of pretax cost savings do we require for this project to be profitable? MACRS schedule. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
A proposed cost-saving device has an installed cost of $640,000. The device will be used in a five-year project but is classified as three-year MACRS property for tax purposes. The required initial net working capital investment is $55,000, the marginal tax rate is 35 percent, and the project discount rate is 12 percent. The device has an estimated Year 5 salvage value of $60,000. What level of pretax cost savings do we require for this project to be profitable? MACRS schedule. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Explanation / Answer
let X be the pretax cost savings
cash flow in year 0 = -640000 - 55000 = 695000
cash flow in year 1 = (X - 640000 * 0.2) (1-0.35) + 640000 * 0.2 = 0.65 X - 44800
cash flow in year 2 = (X - 640000 * 0.32) (1-0.35) + 640000 * 0.32 = 0.65 X - 71680
cash flow in year 3 = (X - 640000 * 0.1920) (1-0.35) + 640000 * 0.1920 = 0.65 X - 43008
cash flow in year 4 =(X - 640000 * 0.1152) (1-0.35) + 640000 * 0.1152 = 0.65 X - 25804.80
cash flow in year 5 = (X - 640000 * 0.1152) (1-0.35) + 640000 * 0.1152 = 0.65 X - 25804.80
for the project to profitable NPV should be greater than or equal to zero
=>
0 = -69500 + 0.65 X* [ 1/1.12+ 1/1.12^2 + 1/1.12^3 + 1/1.12^4 + 1/1.12^5] - 44800/1.12 - 71680/1.12^2 - 43008/1.12^3 - 25804.80/1.12^4 - 25804.80/1.12^5 + 55000/1.12^5
=>
822588.378412 = 0.65 X* [ 1/1.12+ 1/1.12^2 + 1/1.12^3 + 1/1.12^4 + 1/1.12^5]
=>
X = $351,067.73 ..............ans
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