Ben Alexander, an enterprising young engineering graduate who worked part-time a
ID: 2654408 • Letter: B
Question
Ben Alexander, an enterprising young engineering graduate who worked part-time as a machinist during collage, decided to establish his own mechanical design and specialty manufacturing business after graduating. His workload is increasing due to a few good contracts, and he is spending longer hours on hands-on machining tasks producing fabricated metal products.
Ben is considering the purchase of a bed-type milling machine with automatic table feed and other features.
The cost of the machine is $21,000 with an expected life of 12 years. He would keep it for only 5 years, however, and be able to sell it for $5,000 at that time. Ben has a time limitation of only 500 hours per year that he can devote to milling operations, even though he can sell everything he produces.
If he buys the mill, he will be able to complete parts in 4 minutes each.
If he does not purchase the mill, he will continue producing with current equipment at a rate of 12 minutes each. Each part he turns out provides a net income before tax of $2.
A third alternative, in addition to buying or not, includes leasing the milling machine for $4,000 paid annually at the beginning of the year. Marginal taxes are 40 percent, and the after-tax MARR is 9 percent. Create a spreadsheet to determine the best alternative. (depreciation under 3-year MACRS-GDS is applicable)
Explanation / Answer
Evaluating the Three options
Option 1: Purchase a milling machine with $21,000 initial investment and selling at $5,000 at end of year5. Here we use the MARCS depreciation table.
One part is produced in 4 minutes. Therefore, in an hour he produces 15 parts and in a year of 500 hours, he produces 7,500 units giving him a net income of $15,000
The calculation is shown below:
Description
0
Year 1
Year 2
Year 3
Year 4
Year 5
Intial Outflow
-21000
0
0
0
0
0
Cash Inflow
0
15000
15000
15000
15000
15000
Taxes (Outflow)
0
-6000
-6000
-6000
-6000
-6000
Net Cash Flow
0
9000
9000
9000
9000
9000
Add Back Depriciation
0
4200
6720
4032
2419
2419
Total Cash Flow
-21000
13200
15720
13032
11419
11419
Salvage Value
0
0
0
0
0
5000
Total Cash Flow
-21000
13200
15720
13032
11419
16419
Present Worth
33165.13
(with MAAR as 9%)
Option 2: On doing on his own. One part is produced in 12 minutes. Therefore, in an hour he produces 5 parts and in a year of 500 hours, he produces 2,500 units giving him a net income of $5,000
The calculation is shown below:
Description
0
Year 1
Year 2
Year 3
Year 4
Year 5
Intial Outflow
0
0
0
0
0
0
Cash Inflow
0
5000
5000
5000
5000
5000
Taxes (Outflow)
0
-2000
-2000
-2000
-2000
-2000
Net Cash Flow
0
3000
3000
3000
3000
3000
No Depriciation ans Salvage Value
Present Worth
11668.95
(with MAAR as 9%)
Option3: He leases the machine which involves an outflow of $4,000 each year. With the machine he can have a cash inflow of $15,000 as in option 1.
The calculation is shown below:
Description
0
Year 1
Year 2
Year 3
Year 4
Year 5
Intial Outflow
0
0
0
0
0
0
Lease Outflow
0
-4000
-4000
-4000
-4000
-4000
Cash Inflow
0
15000
15000
15000
15000
15000
Taxes (Outflow)
0
-6000
-6000
-6000
-6000
-6000
Net Cash Flow
0
5000
5000
5000
5000
5000
No Depricitaion and Salvage Value
Present Worth
19448.26
(with MAAR as 9%)
Therefore Option 1 where he purchases a milling machine is best as it gives him the best present value.
Therefore, he should go with Option 1.
Description
0
Year 1
Year 2
Year 3
Year 4
Year 5
Intial Outflow
-21000
0
0
0
0
0
Cash Inflow
0
15000
15000
15000
15000
15000
Taxes (Outflow)
0
-6000
-6000
-6000
-6000
-6000
Net Cash Flow
0
9000
9000
9000
9000
9000
Add Back Depriciation
0
4200
6720
4032
2419
2419
Total Cash Flow
-21000
13200
15720
13032
11419
11419
Salvage Value
0
0
0
0
0
5000
Total Cash Flow
-21000
13200
15720
13032
11419
16419
Present Worth
33165.13
(with MAAR as 9%)
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