You have been asked by the president of your company to evaluate the proposed ac

Question

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose machine. The machine's basic price is $60,000 and the delivery and installation fee is $10,000. The machine falls into the four-year class using straight line depreciation method, and it will be sold after four years for $0. The use of this new machine will bring revenue of $25,000 annually for 4 years, and will have annual maintenance expense of $5,000. The firm's marginal tax rate is 40 percent and the required rate of return is 10%. (Please show your work)
a. What is the initial investment? (3 points)
b. What is the Cash Flow at year 1? (3 points)
c. What is the Cash Flow at year 4? (3 points)
d. Is this a good investment? (hint: Compute NPV) (3 poin

Explanation / Answer

Initial investment = 60000 + 10000 = $70,000 Annual depreciation = 70000 / 4 = 17500 Cash flow at year 1 = (revenue - maintenance expense - depreciation) * (1-tax rate) + depreciation = (25000 - 5000 - 17500)*(1-0.4) + 17500 = $19,000 Cash flow at year 4 is the same since the asset has a salvage value of 0 and there is no release of net working capital. Cash flow at year 4 = $19,000 NPV is the present value of the following cash flows discounted at 10% Year 0: -70,000 Year 1 to 4: 19000 NPV = -$9,772.56 Since the NPV is negative, it is not a good investment

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