A company is considering the purchase of a new machine that will enable it to in
ID: 2633604 • Letter: A
Question
A company is considering the purchase of a new machine that will enable it to increase its expected sales. The machine will have a direct cost of $100,000. In addition, the machine must be installed and tested. The costs of installation and testing will amount to $40,000. The machine will be depreciated using 5-years MACRS.
The equipment will be operated for 6 years. The sales in the first year of operation are expected to be $200,000. Then, sales will grow by 5% per year until the sixth year. The annual operating costs (before depreciation) will consist of fixed operating costs of $25,000 plus variable operating costs equal to 75% of sales.
To support the increased level of production, the inventory of raw materials will have to be increased from $40,000 to $50,000 when the machine is purchased. The additional inventory will be carried until the machine is scrapped following the 6 years of operation.
At the end of the 6-year operating life of the project, it is assumed that the equipment will be sold for $60,000. The tax rate is 40%.
If the new machine is purchased, it will be financed by borrowing the required funds at an interest rate of 8%. The company
Explanation / Answer
1)
0
1
2
3
4
5
6
Initial cost
-140000
Sales
200000
210000
220500
231525
243101.3
255256.3
Variable cost
-150000
-157500
-165375
-173644
-182326
-191442
Fixed cost
-25000
-25000
-25000
-25000
-25000
-25000
Depreciation %
20%
32%
19.20%
11.52%
11.52%
5.76%
Depreciation
-28000
-44800
-26880
-16128
-16128
-8064
Net income
-1800
-11245
2109.25
10889.61
12770.75
19987.55
Operating cash flow
26200
33555
28989.25
27017.61
28898.75
28051.55
2) Initial outlay = initial cost + increase in working capital = 140000 +10000= 150,000
3) tax on loss from gain on sale of equipment = (60000-0)*40%= 24000
4) after tax salvage at the terminal year = 60,000-24000= 36,000
5
0
1
2
3
4
5
6
Initial cost
-140000
Sales
200000
210000
220500
231525
243101.3
255256.3
Variable cost
-150000
-157500
-165375
-173644
-182326
-191442
Fixed cost
-25000
-25000
-25000
-25000
-25000
-25000
Depreciation %
20%
32%
19.20%
11.52%
11.52%
5.76%
Depreciation
-28000
-44800
-26880
-16128
-16128
-8064
Net income
-1800
-11245
2109.25
10889.61
12770.75
19987.55
Operating cash flow
26200
33555
28989.25
27017.61
28898.75
28051.55
Increase in working capital
-10000
Recovery of working capital
10000
After tax salvage value
36000
Net cash flows
-150000
26200
33555
28989.25
27017.61
28898.75
74051.55
NPV
$4,100.53
IRR
10.30%
PI
1.03
6) book value after 4 years = 24192
after tax salvage = 5000
1)
0
1
2
3
4
5
6
Initial cost
-140000
Sales
200000
210000
220500
231525
243101.3
255256.3
Variable cost
-150000
-157500
-165375
-173644
-182326
-191442
Fixed cost
-25000
-25000
-25000
-25000
-25000
-25000
Depreciation %
20%
32%
19.20%
11.52%
11.52%
5.76%
Depreciation
-28000
-44800
-26880
-16128
-16128
-8064
Net income
-1800
-11245
2109.25
10889.61
12770.75
19987.55
Operating cash flow
26200
33555
28989.25
27017.61
28898.75
28051.55
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