Warmack Machine Shop is considering a four-year project to improve its productio
ID: 2724363 • Letter: W
Question
Warmack Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $530,000 is estimated to result in $220,000 in annual pretax cost savings. The press falls in the MACRS five-year class, and it will have a salvage value at the end of the project of $89,000. The press also requires an initial investment in spare parts inventory of $26,000, along with an additional $3,100 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and its discount rate is 9 percent. MACRS schedule
Calculate the NPV of this project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Warmack Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $530,000 is estimated to result in $220,000 in annual pretax cost savings. The press falls in the MACRS five-year class, and it will have a salvage value at the end of the project of $89,000. The press also requires an initial investment in spare parts inventory of $26,000, along with an additional $3,100 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and its discount rate is 9 percent. MACRS schedule
Explanation / Answer
Initial Investment = $530,000 + $26,000 = $556,000
After-tax salvage value = $89,000 – [($89,000 - $30,528) x 35%] = $68,534.80
5 Years Depreciation Schedule
Year
Basis
%
Depreciation Expense
Accumulated Depreciation
Ending Book Value
1
$530,000.00
20.000%
$106,000.00
$106,000.00
$424,000.00
2
$530,000.00
32.000%
$169,600.00
$275,600.00
$254,400.00
3
$530,000.00
19.200%
$101,760.00
$377,360.00
$152,640.00
4
$530,000.00
11.520%
$61,056.00
$438,416.00
$91,584.00
5
$530,000.00
11.520%
$61,056.00
$499,472.00
$30,528.00
6
$530,000.00
5.760%
$30,528.00
$530,000.00
$0.00
Operating Cash Flow:
Year
1
2
3
4
5
Pre-tax Savings
$220,000.00
$220,000.00
$220,000.00
$220,000.00
$220,000.00
Less: Depreciation
$106,000.00
$169,600.00
$101,760.00
$61,056.00
$61,056.00
Net pre-tax savings
$114,000.00
$50,400.00
$118,240.00
$158,944.00
$158,944.00
Less: Tax @ 35%
$39,900.00
$17,640.00
$41,384.00
$55,630.40
$55,630.40
After-tax savings
$74,100.00
$32,760.00
$76,856.00
$103,313.60
$103,313.60
Less: Change in NWC
$3,100.00
$3,100.00
$3,100.00
$3,100.00
$3,100.00
Add: Depreciation
$106,000.00
$169,600.00
$101,760.00
$61,056.00
$61,056.00
Add: Recovery of initial NWC
$0.00
$0.00
$0.00
$0.00
$26,000.00
Add: After-tax salvage value
$0.00
$0.00
$0.00
$0.00
$68,534.80
Operating Cash Flow
$177,000.00
$199,260.00
$175,516.00
$161,269.60
$255,804.40
NPV = -$556,000 + [($177,000)/(1.09)] + [($199,260)/(1.09)2] + [($175,516)/(1.09)3] + [($161,269.60)/(1.09)4] + [($255,804.40)/(1.09)5] = $190,131.79
IRR
0 = -$556,000 + [($177,000)/(IRR)] + [($199,260)/(IRR)2] + [($175,516)/(IRR)3] + [($161,269.60)/(IRR)4] + [($255,804.40)/(IRR)5] = 20.94%
5 Years Depreciation Schedule
Year
Basis
%
Depreciation Expense
Accumulated Depreciation
Ending Book Value
1
$530,000.00
20.000%
$106,000.00
$106,000.00
$424,000.00
2
$530,000.00
32.000%
$169,600.00
$275,600.00
$254,400.00
3
$530,000.00
19.200%
$101,760.00
$377,360.00
$152,640.00
4
$530,000.00
11.520%
$61,056.00
$438,416.00
$91,584.00
5
$530,000.00
11.520%
$61,056.00
$499,472.00
$30,528.00
6
$530,000.00
5.760%
$30,528.00
$530,000.00
$0.00
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