Thornley Machines is considering a 3-year project with an initial cost of $690,0
ID: 2717848 • Letter: T
Question
Thornley Machines is considering a 3-year project with an initial cost of $690,000. The project will not directly produce any sales but will reduce operating costs by $405,000 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 $75,000. The tax rate is 34 percent. The project will require $17,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 13 percent? Why or why not?
Explanation / Answer
Statemnet showing Cash flows Particulars Time PVf@13% Amount PV Cash Outflows (Initial invt) - 1.00 (690,000.00) (690,000.00) Cash Outflows (wC) - 1.00 (17,000.00) (17,000.00) PV of Cash outflows (707,000.00) Cash inflows 1.00 0.8850 345,500.00 305,752.21 Cash inflows 2.00 0.7831 345,500.00 270,577.18 Cash inflows 3.00 0.6931 345,500.00 239,448.83 Cash inflows 3.00 0.6931 49,500.00 34,305.98 Cash inflows 3.00 0.6931 17,000.00 11,781.85 PV of Cash Inflows 861,866.06 NPV 154,866.06 Yes since NPV Is positive Reduction in operating costs 405,000.00 Savings in Operating costs net of tax(455000*.66) 267,300.00 Cost of project 690,000.00 Depreciation = 690,000/3 230,000.00 Tax Savings on dep = 230,000*.34 78,200.00 Total Savings = 267,300+ 78200 345,500.00 Salvage Value 75,000.00 Salvage Value net of tax(75000*.66) 49,500.00
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