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Carlson Machine Shop is considering a four-year project to improve its production efficiency by purchasing a new machine press for $430,000. The machine press will result in $160,000 in annual pre-tax labor cost savings. The press will be depreciated using the 5 year MACRS depreciation schedule and they expect to be able to sell it for $70,000 at the end of four years.
The new press will require an initial inventory of $20,000 in spare parts for maintenance which will decrease by $4,000 a year over the four years. The $4,000 in unused spare parts inventory will be worthless at the end of the project but will still have a Net Book Value of $4,000.
Carlson has a 14% cost of capital and a 35% tax rate.
1. Use the Five Year Projection Worksheet to calculate the incremental Free Cash Flow and NPV. Should they buy the machine?
2. Recalculate the NPV assuming the machine press can only be sold for $45,000 at the end of year four. Does this change have an impact on their decision?
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