Answer:
Since the NPV is positive, then the company should buy and install the machine press.
Explanation:
We have to calculate the NPV of the project using the discount cash flow model:
the initial investment = $385,000 (depreciable machinery) + $20,000 spare parts + $3,100 = $408,100
depreciation expense (five year MACRS class)
- $385,000 x 20% = $77,000
- $385,000 x 32% = $123,200
- $385,000 x 19.20% = $73,920
- $385,000 x 11.52% = $44,352
- $385,000 x 11.52% = $44,352
- $385,000 x 5.76% = $22,176
Cash flow year 1 = [($145,000 - $77,000) x (1 - 22%)] + $77,000 = $130,040
Cash flow year 2 = [($145,000 - $123,200) x (1 - 22%)] + $123,200 = $140,204
Cash flow year 3 = [($145,000 - $73,920) x (1 - 22%)] + $73,920 = $129,362
Cash flow year 4 = {[($145,000 - $44,352) x (1 - 22%)] + $44,352} + $3,100 (recovered working capital) + $45,000 (salvage value) + $4,736 (tax credit on impairment loss*) = $175,693
*since the carrying value at the end of year 4 is $66,528 and the salvage value is $45,000, an impairment loss will = $21,528. This will result in lower taxes by $21,528 x 22% = $4,736
the NPV of the project = -$408,100 + $130,040/1.09 + $140,204/1.09² + $129,362/1.09³ + $175,693/1.09⁴ = -$408,100 + $119,303 + $118,007 + $99,891 + $124,465 = $53,566
Since the NPV is positive, then the company should buy and install the machine press.
