Caradoc Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $410,000 is estimated to result in $150,000 in annual pre-tax cost savings. The press falls into Class 8 for CCA purposes (CCA rate of 20 percent per year), and it will have a salvage value at the end of the project of $55,000. The press also requires an initial investment in spare parts inventory of $20,000, along with an additional $3,100 in inventory for each succeeding year of the project. If the shop’s tax rate is 35 percent and its discount rate is 9 percent. Calculate NVP
To calculate the Net Present Value (NPV), you need to calculate the present value of each cash flow associated with the project and then subtract the initial investment cost. Here's how you can calculate the NPV:
1. Calculate the annual cash inflow: The annual pre-tax cost savings from the new machine press is $150,000.
2. Calculate the annual depreciation expense: The new machine press falls into Class 8 for CCA purposes, with a CCA rate of 20 percent per year. The initial cost of the press is $410,000, and it will have a salvage value of $55,000 at the end of the project. Therefore, the annual depreciation expense can be calculated as follows:
Depreciation Expense = (Initial Cost - Salvage Value) * CCA Rate
= ($410,000 - $55,000) * 0.20
= $71,000
3. Calculate the annual after-tax cash flow: To calculate the after-tax cash flow, you need to subtract the tax savings from the depreciation expense. Multiply the depreciation expense by the tax rate (35%) to find the tax savings:
Tax Savings = Depreciation Expense * Tax Rate
= $71,000 * 0.35
= $24,850
After-Tax Cash Flow = Annual Pre-tax Cash Inflow - Tax Savings
= $150,000 - $24,850
= $125,150
4. Calculate the present value of the cash flows: To calculate the present value of the cash flows, you need to discount each cash flow to its present value. The discount rate is given as 9%. Use the formula:
Present Value = Cash Flow / (1 + Discount Rate)^n
where n is the year of the cash flow.
Year 0:
Present Value = -$410,000 (Initial investment cost)
Year 1:
Present Value = $125,150 / (1 + 0.09)^1
= $125,150 / 1.09
= $114,678.90
Year 2:
Present Value = $125,150 / (1 + 0.09)^2
= $125,150 / 1.1881
= $105,281.02
Year 3:
Present Value = $125,150 / (1 + 0.09)^3
= $125,150 / 1.2950
= $96,590.21
Year 4:
Present Value = ($125,150 + $55,000) / (1 + 0.09)^4
= $180,150 / 1.4116
= $127,733.73
5. Calculate the total present value of the cash flows: Sum up the present values calculated in Step 4:
Total Present Value = Year 0 Present Value + Year 1 Present Value + Year 2 Present Value + Year 3 Present Value + Year 4 Present Value
= -$410,000 + $114,678.90 + $105,281.02 + $96,590.21 + $127,733.73
= $34,283.86
6. Calculate the NPV: Finally, subtract the initial investment cost from the total present value to calculate the NPV:
NPV = Total Present Value - Initial Investment
= $34,283.86 - $410,000
= -$375,716.14
The NPV of the project is -$375,716.14. This means that the project is expected to result in a negative net present value, indicating that the present value of the cash inflows is lower than the initial investment cost.