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SM Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $435,000 is estimated to result in $164,000 in annual pretax cost savings. The press is eligible for 100 percent bonus depreciation and it will have a salvage value at the end of the project of $65,000. The press also requires an initial investment in spare parts inventory of $17,000, along with an additional $4,000 in inventory for each succeeding year of the project. The shop’s tax rate is 25 percent and its discount rate is 12 percent.

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abiolataiwo2015

If  the shop’s tax rate is 25 percent and its discount rate is 12 percent. Net present value is $43,334.

Net present value

Working capital for each years

Year                     0                1             2          3        4

Working capital  -17,000    -4000 -4000 -4000  29,000

Working capital invested from 0-3  will be recovered in year 4.    

Net present value    

Year                 0                  1                    2                   3                  4

Cost savings                  $164,000  $164,000     $164,000           $164,000

Depreciation                  -$87,000  -$139,200   -$83,520            -$50,112

Savings before tax           $77,000   $24,800 $80,480          $113,888

Taxes 25%                   -$19,250    -$6,200 -$20,120          -$28,472

Net income                       $57,750     $18,600 $60,360            $85,416

Add: Depreciation             $87,000   $139,200 $83,520            $50,112

Operating cash flow         $144,750  $157,800   $143,880          $135,538

Purchase of machine -435,000    

Investment in working capital-17,000   -4000 -4000 -4000         $29,000

Aftertax salvage value                                                                      $67,542

Net cash flow  -$452,000   $140,750  $153,800   $139,880      $232,080

Discount factor 12% 1         0.89286   0.79719      0.71178           0.63552

Present value -$452,000 $125,670 $122,608   $99,565          $147,491

Net present value $43,334  

Workings:

Calculation of depreciation based on MACRS    

Year      

1 435000×0.20=$87,000    

2 435000×0.32 =$139,200    

3 435000×0.1920=$83,520    

4 435000×0.1152=$50,112  

Total                            $359,832

 

Calculation of aftertax salvage value      

Sale proceeds                             $65,000    

Less: Book value of machine     $75,168

(435000-359,832)  

Loss on sale of machine             -$10,168    

Tax benefit 25%                            $2,542    

After tax salvage value              $67,542

($65,000+$2,542)

Therefore the project's NPV is $43,334.    

Learn more about net present value here: https://brainly.com/question/16342970

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