1 answer

CSM Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $545,000 is estimated to

Question:

CSM Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $545,000 is estimated to result in $197,000 in annual pretax cost savings. The press falls in the MACRS five-year class, and it will have a market value at the end of the project of $70,000. The press also requires an initial investment in spare parts inventory of $21,000, along with an additional $3,000 in inventory for each succeeding year of the project. If the shop's tax rate is 34% and its discount rate is 11%, fill in the below blanks. 

Depreciation Amount

Year 1:________

Year 2:________

Year 3:________

Year 4:________

Book value of the equipment at the end of the project is_______.

              Operating cash flows   Project cash flows

Year 1

Year 2

Year 3 

Year 4

The NPV of the project is_______.


Answers

Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows. If the net present value is positive, the project is considered worth accepting, if the net present value is negative then the project is rejected.

The new machine cost is $545,000. The annual pre-tax cost savings are $197,000 each year. The depreciation is based on MACRS 5-year class. The salvage value is $70,000.

The initial investment in inventory (net working capital) is $21,000 and additional $3,000 for next 4 years. The tax rate is 34%, and discount rate is 11%.

The book value of the asset after 4 years is $94,176 after deducting 4 years depreciation, but the salvage value of the asset is $70,000. This means that the asset is sold for loss and there will be a tax shield.

Calculate the after-tax salvage value from the sale as follows:

Therefore, the after-tax salvage value is .

The following are the data inputs in spreadsheet:

Picture 2

The following are the obtained results:

Picture 1

Therefore, the net present value (NPV) of the project is , which is positive and company should buy and install the machine press.

.

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