Question

St. Johns River Shipyards' welding machine is 15 years old, fully depreciated, and has no salvage value. However, even though it is old, it is still functional as originally designed and can be used for quite a while longer. The new welder will cost $81,500 and have an estimated life of 8 years with no salvage value. The new welder will be much more efficient, however, and this enhanced efficiency will increase earnings before depreciation from $29,000 to $58,000 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 40%, and the project cost of capital is 13%. What's the NPV of the project?

Answer 1

The project's NPV is $91,950, indicating that it is a profitable investment based on the given assumptions.

Calculate the yearly after-tax cash inflows:

Current earnings before depreciation: $29,000

Increased earnings with new welder: $58,000 - $29,000 = $29,000

Tax savings from depreciation (depreciation expense x tax rate):

Year 1: $81,500 * 20.00% * 40% = $6,520

Year 2: $81,500 * 32.00% * 40% = $10,240

Year 3: $81,500 * 19.20% * 40% = $6,144

Year 4: $81,500 * 11.52% * 40% = $3,686

Year 5: $81,500 * 11.52% * 40% = $3,686

Year 6: $81,500 * 5.76% * 40% = $1,843

Add increased earnings and tax savings to get after-tax cash inflows:

Year 1: $29,000 + $6,520 = $35,520

Year 2: $29,000 + $10,240 = $39,240

Year 3: $29,000 + $6,144 = $35,144

Year 4: $29,000 + $3,686 = $32,686

Year 5: $29,000 + $3,686 = $32,686

Year 6: $29,000 + $1,843 = $30,843

Calculate the present value of each year's cash inflow using the project cost of capital (13%):

Year 1: $35,520 / (1 + 13%)^1 = $31,509

Year 2: $39,240 / (1 + 13%)^2 = $32,922

Year 3: $35,144 / (1 + 13%)^3 = $29,205

Year 4: $32,686 / (1 + 13%)^4 = $25,802

Year 5: $32,686 / (1 + 13%)^5 = $22,725

Year 6: $30,843 / (1 + 13%)^6 = $19,787

Calculate the present value of the initial investment:

Initial cost of new welder: $81,500 / (1 + 13%)^0 = $81,500

Calculate the NPV by summing the present values of all cash flows:

NPV = Present value of inflows - Present value of outflow

NPV = $31,509 + $32,922 + $29,205 + $25,802 + $22,725 + $19,787 - $81,500

NPV = $91,950