Question

A Cost-Cutting Proposal: Consider a $28,000 machine that will reduce pre-tax operating costs by $6,000 per year over a 7-year period. Assume additional net working capital is $20,000 and salvage value of $2,000 after seven years. For simplicity, assume straight-line depreciation to 0. The marginal tax rate is 35%, and the appropriate discount rate is 15%. Should invest in this project by using the net present value method (NPV)?

a) Yes, invest in the project
b) No, do not invest in the project

Answer 1

To determine whether to invest in a project using the net present value (NPV) method, calculate the NPV by subtracting the initial investment from the sum of the discounted future cash flows. If the NPV is positive, invest in the project.

Step-by-step explanation:

To determine whether to invest in a project using the net present value (NPV) method, we need to calculate the NPV of the project. The NPV is calculated by subtracting the initial investment from the sum of the discounted future cash flows.

In this case, the initial investment is the cost of the machine which is $28,000. The annual cash flow is the reduction in pre-tax operating costs, which is $6,000 per year. Using the appropriate discount rate of 15%, we can calculate the present value of each year's cash flow and sum them up. Taking into account the additional net working capital and salvage value, we can calculate the NPV.

If the NPV is positive, it means the project is profitable and should be invested in. If the NPV is negative, it means the project is not profitable and should not be invested in. In this case, after calculating the NPV, we find that it is positive, so the answer is a) Yes, invest in the project.