Thornley Machines is considering a 3-year project with an initial cost of $600,0

Question

Thornley Machines is considering a 3-year project with an initial cost of $600,000. The project will not directly produce any sales but will reduce operating costs by $310,000 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 $66,000. The tax rate is 34 percent. The project will require $14,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 10 percent? Why or why not? Select answer below: yes; The NPV is $107,161.53 yes; The NPV is $163,813.37 yes; The NPV is $54,760.00 no; The NPV is $121,161.53 yes; The NPV is $47,161.53

Explanation / Answer

Answer: yes; The NPV is $107,161.53

Annual depreciation = $600,000 / 3 = $200,000

Cash flow t = 0 = – ($600,000 + $14,000) = –$614,000

Cash flow t = 1 = {[$0 – (–$310,000)] × (1 – 0.34)} + ($200,000 × 0.34) = $272,600

Cash flow t = 2 = $272,600 Cash flow t = 3 = $272,600 + $66,000 × (1 – 0.34) + $14,000 = $330,160

NPV = –$614,000 + $272,600 / (1 + 0.10) + $272,600 / (1 + 0.10) 2 + $330,160 / (1 + 0.10) 3

= $107,161.53

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