Thornley Machines is considering a 3-year project with an initial cost of $990,0
ID: 2707489 • Letter: T
Question
Thornley Machines is considering a 3-year project with an initial cost of $990,000. The project will not directly produce any sales but will reduce operating costs by $600,000 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 $146,000. The tax rate is 34 percent. The project will require $27,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 15 percent? Why or why not? PLEASE SHOW ALL WORK!!!
Explanation / Answer
Solution:
Total investment Required = Initail Machinery cost + Extra Working Capital required
Total investment Required = 990000 + 27000
Total investment Required = 1017000
Depreciation per year = 990000/3 = $ 330000
Annual cash flow = (Annual Reduced Cost)*(1-tax rate) + Depreciation*tax rate
Annual cash flow = 600000*0.66 + 330000*0.34
Annual cash flow =$ 508200
Profit on salvage Value = Salvage Value- Book value = 146000 -0 = $ 146000
Tax on profit on salvage Value = 146000*0.34 = 49640
After tax salvage Value = Salvage Value - Tax on profit on salvage Value
After tax salvage Value = 146000-49640
After tax salvage Value = $ 96360
Terminal value = After tax salvage Value+ Extra Working Capital realised
Terminal value =96360 + 27000
Terminal value =$ 123360
NPV = 508200 * PVIFA(15%,3) + 123360* PVIF(15%,3) - 1017000
NPV = 508200 * 2.283225 + 123360* 0.657516- 1017000
NPV = $ 224,446
Since NPV Is positive, This Project should be implemented
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