Thornley Machines is considering a 3-year project with an initial cost of $1,050

Question

Thornley Machines is considering a 3-year project with an initial cost of $1,050,000. 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 $159,000. The tax rate is 34 percent. The project will require $29,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 17 percent? Why or why not? no; The NPV is $171,564.45 yes; The NPV is $271,259.87 yes; The NPV is $142,564.45 yes; The NPV is $22,029.71 yes; The NPV is $243,940.00

Explanation / Answer

Step:1 Intitial cash outflow in the beggining of the year

Cost of asset =$ 1,050,000

Working capital =$ 29000

total outflow =$ 1,079,000

Step 2: In between cash flows

Step: 3 Terminal cash flows

Sale proceeds =159,000

Less: Tax @34%=54060

Net sale proceeds =$ 104,940

Add: recoupment of working capital =$ 29,000

Total termial cash inflow =$ 133,940

Step:4 Evaluation of project

Yes, Project should be implemented since it has positive NPV

Year 1 2 3 Savings in operating cost $600,000 $600,000 $600,000 Less: Depreciation $350,000 $350,000 $350,000 Savings before tax $250,000 $250,000 $250,000 Tax@34% $ 85,000 $ 85,000 $ 85,000 Savings after tax $165,000 $165,000 $165,000 Add: Depreciation $515,000 $515,000 $515,000

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