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NPV and IRR for SBS Automated Materials-Handling System

SBS Automated Materials-Handling System
Skanda Business Solution., (SBS) is an established manufacturer of microwavable frozen foods. In a bid to control costs and increase efficiency at its Western Plant, SBS is considering acquiring an automated materials-handling system. The plan involves replacing the current stock of forklift trucks with a computer-controlled conveyor belt system that feeds directly into the refrigeration units. This automation will eliminate the need for a number of personnel in the materials-handling department, and it will increase the output capacity of the plant.

Automated Materials-Handling System Projections
Projected useful life 10 years
Purchase and installation of equipment $4,500,000
Working capital investment required 1,000,000
Increase in annual operating costs (exclusive of depreciation) 200,000
Equipment repairs to maintain productive efficiency (end of year 5) 800,000
Increase in annual sales revenue 700,000
Reduction in annual manufacturing costs 500,000
Reduction in annual maintenance costs 300,000
Estimated salvage value of automated materials-handling system at end of useful life 850,000

The forklift trucks currently have a net book value of $500,000. They are being depreciated on a straight-line basis with a 5-year remaining useful life and zero salvage value. If the Automated Materials-Handling System were purchased now, the forklifts could be sold today for $100,000.

The equipment for the automated materials-handling system will be depreciated over 10-year useful life, also by the straight-line method, but assuming a salvage value of $850,000. (Disregard the half-year convention and assume a full yearâ??s depreciation is recorded in each of the 10 years.) SBS uses the same depreciation methods and assumptions both for book purposes and for tax purposes, so there are no deferred taxes. SBS has a 40% tax rate. For purposes of this analysis, assume that all cash flows and the related tax effects from the initial investment (acquisition of the new system and disposal of the old equipment) occur immediately. All other cash flows and tax effects are assumed to occur at the end of each period.

1. Assume that SBS requires a minimum return of 12% on any capital investment. Determine the Net Present Value (NPV) of this proposal.
2. Compute the Internal Rate of Return (IRR) for this proposal.
3. Should SBS undertake this project?

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Solution Summary

This solution provides the calculations for NPV in an attached Word document.