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.

How should the $5,000 spent last year behandled?

Explanation / Answer

            Thefirm spent $5,000 for last year investigating the feasibility ofusing the machine. It would be treated as a SunkCost. Why because sunk cost is the historical costincurred in the past. This $5,000 may not be useful for thedecision making process.

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