Question

Masters Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $450,000 is estimated to result in $184,000 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 $74,000. The press also requires an initial investment in spare parts inventory of $33,000, along with an additional $3,750 in inventory for each succeeding year of the project. The shop’s tax rate is 23 percent and its discount rate is 10 percent. (MACRS schedule)

Required:
Calculate the NPV of this project.

Answer 1

Masters Machine Shop

PV of Salvage value = $74,000 x 0.683 = $50,542

Present value of total savings $449,126

less Present value of investments 494,888

Net Present Value $4,780

Step-by-step explanation:

a) Data Amount Present Value

Cash Outflow $450,000 $450,000

Initial spare parts 33,000 33,000

Annual Inventory 3,750 11,888

PV of investments $494,888

Project lifespan = 4 years

Discount rate = 10%

Annual pretax cost savings = $184,000

Tax rate 23% 42,320

After Tax savings $141,680

PV of Annuity of Tax savings = $141,680 x 3.170 = $449,126

Salvage value = $74,000

PV of Salvage value = $74,000 x 0.683 = $50,542

Present value of total savings $449,126

less Present value of investments 494,888

Net Present Value $4,780

b) Master Machine Shop's Net Present Value (NPV) is the difference between the cash inflows (savings) and the cash outflows (investments) for this four-year project