Purple Haze Machine Shop is considering a four-year project to improve its produ

Question

Purple Haze Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $390,000 is estimated to result in $150,000 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 $66,000. The press also requires an initial investment in spare parts inventory of $12,000, along with an additional $1,700 in inventory for each succeeding year of the project. The shop’s tax rate is 35 percent and its discount rate is 9 percent.Refer to Table.

Calculate the NPV of this project. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

NPV ______ ?

Calculate the NPV of this project. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

NPV ______ ?

Explanation / Answer

Initial Investment = 390000 + 12000 = $ 402000

Depreciation Tax shield in year 1 = 390000*20%*35% = 27300

Depreciation Tax shield in year 2 = 390000*32%*35% = 43680

Depreciation Tax shield in year 3 = 390000*19.20%*35% = 26208

Depreciation Tax shield in year 4 = 390000*11.52%*35% = 15724.80

Book Value at the end of 4 year = 390000*(1-20%-32%-19.20%-11.52%)

Book Value at the end of 4 year = 67392

Posttax salvage value = salvage value - Tax rate(salvage value - book value)

Posttax salvage value = 66000 - 35%*(66000-67392)

Posttax salvage value = 66487.20

Terminal Value = Posttax salvage value + working capital recovered

Terminal Value = 66487.20 + (12000 + 1700*3)

Terminal Value = $ 83587.20

Cash Flow in year 1 = annual pretax cost savings *(1-tax rate) + Depreciation Tax shield - inventory

Cash Flow in year 1 = 150000*(1-35%) + 27300 - 1700

Cash Flow in year 1 = 123100

Cash Flow in year 2 = annual pretax cost savings *(1-tax rate) + Depreciation Tax shield - inventory

Cash Flow in year 2 = 150000*(1-35%) + 43680 - 1700

Cash Flow in year 2 = 139480

Cash Flow in year 3 = annual pretax cost savings *(1-tax rate) + Depreciation Tax shield - inventory

Cash Flow in year 3 = 150000*(1-35%) + 26208 - 1700

Cash Flow in year 3 = 122008

Cash Flow in year 4 = annual pretax cost savings *(1-tax rate) + Depreciation Tax shield + terminal value

Cash Flow in year 4 = 150000*(1-35%) + 26208 + 83587.20

Cash Flow in year 4 = 207,295.20

NPV = -402000 + 123100/(1+9%) + 139480/(1+9%)^2 + 122008/(1+9%)^3 + 207295.20/(1+9%)^4

NPV = $ 63,399.01

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