You must evaluate a proposal to buy a new milling machine. The base price is $10

Question

You must evaluate a proposal to buy a new milling machine. The base price is $108,000, and shipping and installation costswould add another $12,500. The machine falls into the MACRS3-year class, and it would be sold after 3 years for $65,000. The applicable depreciation rates are 33, 45, 15 and 7 percent asdiscussed in Appendix 12A of your text book. The machinewould require a $5,500 increase in working capital (increasedinventory less increased accounts payable). There would be noeffect on revenues, but pre-tax labor costs would decline by$44,000 per year. The marginal tax rate is 35 percent, andthe WACC is 12 percent. Also, the firm spent $5,000 last yearinvestigating the feasibility of using the machine.

Should the machine be purchased? Explain youranswer.

Explanation / Answer

Year

Cashflows

PV Factor at 12%

Present Values

Net Present Value

Calculating NetPresent Value:

Year

Cashflows

PV Factor at 12%

Present Values

0 ($126,000) 1 ($126,000.00) 1 $42,517.75 0.8929 $37,964.09 2 $47,578.75 0.7972 $37,929.78 3 $85,628.50 0.7118 $60,950.36

Net Present Value

$10,844.23 Note: 3rd year Cash flows = NetOperating Cashflows in 3rd year + Terminal Cashflows          3rd year Cashflows = $34,926.25 + $50,702.25   = $85,628.50 Conclusion: Yes, the Machineshould be Purchased. Why because The NPV is Positive.

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