Superior Manufacturers is considering a 3-year project with an initial cost of $

Question

Superior Manufacturers is considering a 3-year project with an initial cost of $846,000. The project will not directly produce any sales but will reduce operating costs by $295,000 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 $30,000. The tax rate is 34 percent. The project will require $31,000 in extra inventory for spare parts and accessories. Should this project be implemented if Superior Manufacturing requires an 8 percent rate of return? Why or why not?

Explanation / Answer

Year Saving in Operating cost Depreciation Profit before tax TAx Profir after tax Depreciation 1-3 295000 282000 13000 4420 8580 282000

3 (working capital)

3(sale)

Cash inflow PVF(8%, n year) Present value

290580 2.577 748824.66

30000 0.794 23820

31000 0.794 24614

$797258.66

Present value of cash outflow

=846000 + 31000 + [ tax on profit on sale {(0 - 30000) * 34%} ]

=$846000 + 31000 +10200

=887200

Net present value =$797258.66 -   $887200

= ($89941.34)

No, the project should not be implemented,because the NPV is negative

Note:- Depreciation per year = $846000 / 3

   =$282000

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