Mars Inc is considering the purchase of a new machine which will increase revenu

Question

Mars Inc is considering the purchase of a new machine which will increase revenues by $5,000 annually. Mars will use the Modified Accelerated Cost Recovery System (MACRS) accelerated method to depreciate the machine, and it expects to sell the machine at the end of its 5-year operating life for $10,000. The firm expects to be able to reduce net operating working capital by $15,000 in year 0, which it expects to return when the machine is sold after 5 years. Mars’ marginal tax rate is 40%, and it uses a 12% cost of capital to evaluate projects of this nature. If the machine costs $60,000, what is the net present value (NPV) of the project? (MACRS): Year 1=20%, Year 2=32%, Year 3=19%, Year 4=12%, Year 5=11% and Year 6=6%.

I. Initial Outlay 0 1 2 3 4 5 Machine Cost Change in NWC Total Net Investment                   (Line 2 -3) II. Operating CF Increase in EBIT After tax increase in EBIT (Line 6 * (1-t)) Depreciation (Line 1 * MACRS) Tax savings from depreciation (Line 8 * tax rate) Net operating CF (Line 7 + Line 9) III. Terminal Year CF Estimated Salvage Value Tax on Salvage Value = (line 12 – Book Value)*tax rate and Book Value = (cost - sum of depreciation) Return on NWC Total Termination CF (Lines 12 + 13 + 14) IV. Net Cash Flows Total Net Cash Flow (Lines 4 + 10 + 15)

Explanation / Answer

Answer:-

line no 1 I. Initial Outlay 0 1 2 3 4 5 2 Machine Cost -60,000 0 0 0 0 0 3 Change in NWC -15,000 0 0 0 0 0 4 Total Net Investment                   (Line 2 -3) -45,000 0 0 0 0 0 5 II. Operating CF 0 0 0 0 0 0 6 Increase in EBIT 0 5000 10000 15000 20000 25000 7 After tax increase in EBIT (Line 6 * (1-t)) 0 3000 6000 9000 12000 15000 8 Depreciation (Line 1 * MACRS) 0 12000 19200 11400 7200 6600 9 Tax savings from depreciation (Line 8 * tax rate) 0 4800 7680 4560 2880 2640 10 Net operating CF (Line 7 + Line 9) 0 7800 13680 13560 14880 17640 11 III. Terminal Year CF 0 0 0 0 0 -15,000 12 Estimated Salvage Value 0 0 0 0 0 10,000 13 Tax on Salvage Value = (line 12 – Book Value)*tax rate and Book Value = (cost - sum of depreciation) 0 0 0 0 0 2,560 14 Return on NWC 1800 0 0 0 0 -18000 15 Total Termination CF (Lines 12 + 13 + 14) 1800 0 0 0 0 -5440 16 IV. Net Cash Flows(Lines 4+10) -45,000 7,800 13,680 13,560 14,880 17,640 17 Total Net Cash Flow (Lines 4 + 10 + 15) -43,200 7,800 13,680 13,560 14,880 12,200 18 Discounting factor (PVF@12%) 0.8929 0.7972 0.7118 0.6355 0.5674 0.5066 19 PRESANT VALUE -38571.42857 6218.112245 9737.15379 8617.625143 8443.311613 6180.899678 20 NET PRESANT VALUE 625.6738982$ (-38571.42857+6218.112245+9737.15379+8617.625143+8443.311613+6180.899678)

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