massey machine shop is considering a four-year project to improve its production

Question

massey machine shop is considering a four-year project to improve its production efficiency. buying a new machine press for $500,000 is estimated to result in $180,000 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 $70,000. the press also requires an initial investment in spare parts inventory of 20,000 along with an additional 3,000 in inventory for each succeeding year of the project. if the shops tax rate is %35 and its discounted rate is %14 should Massey buy and install the machine press?

year MACRS %

1         20.00%

2           32.00

3         19.20

4           11.52

5        11.52

6          5.76

Explanation / Answer

Assume that the working capitals are returned   at the end of the project: Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 MACRS Rate   20.0% 32.0% 19.2% 11.52% 11.52% 5.76% Machine bbok value after 5 yrs @5.76%=          28,800 Salvage value            70,000 Capital Gain          41,200 Tax @35% on capital gain=          14,420 NPV calculation Investment        (500,000) NWC investment          (20,000)         (3,000)        (3,000)         (3,000)        (3,000)       (3,000) Return of NWC         35,000 Salvage         70,000 Preatx operating cost saving      180,000      180,000       180,000      180,000    180,000 Depreciation    (100,000)    (160,000)       (96,000)      (57,600)    (57,600) Taxable income           80,000        20,000         84,000      122,400    192,400 Less Tax @35%      (28,000)        (7,000)       (29,400)      (42,840)    (67,340) Tax on Salvage      (14,420) Post Tax income=         52,000        13,000         54,600        79,560    110,640 Add Back depreciation      100,000      160,000         96,000        57,600       57,600 Net Cash flow with added depreciation NWC , NWC return, post tax income & Salvage      (520,000)      149,000      170,000       147,600      134,160    270,240 PV factor @14%=                     1           0.877           0.769           0.675          0.592         0.519 PV of Cash flows        (520,000)      130,702      130,809         99,626        79,433    140,354 NPV =          60,925 As the NPV is positive, Massey can buy and install the machine.

Related Questions

Navigate

• Browse (All)
• Browse M
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.