You must evaluate a proposal to buy a new milling machine. The base price is $10
ID: 2698749 • Letter: Y
Question
You must evaluate a proposal to buy a new milling machine. The base price is $108,000 and shipping and installation costs would add another $12,500. the machine falls into the MACRS 3 year class and it would be sold after 3 years for $65,000. The applicable depreciation rates are 33%, 45%, 15% smf 7%. The machine would require a $5,500 increase in net operating, working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $44,000 per yeaer. The marginal tax rate is 35% and the WACC is 12%. The firm spent $5,000 last year investigating the feasibility of using the machine. a. how should the $5,000 spent last year be handled? b. what is the initial investment outlay for the machine for capital budgeting purposes, that is what is the yaer 0 project cash flow?c. What are the project's annual cash flows during years 1, 2, ,and 3? Should the maching be purchased? Explain your answer.
Explanation / Answer
Net Cost of the machine = $108,000 + $12,500 + $5,500=$126,000
Year
0
1
2
3
After-Tax Savings
$28,600
$28,600
$28,600
Depreciation Tax Savings
$13,918
$18,979
$6,326
Net Cash Flow
$42,518
$47,579
$34,926
Salvage Value
$65,000
Tax on Salvage Value
$19,798
NWC Recovery
$5,500
Terminal Cash Flow
$50,702
Yes, the machine should be purchased as the investment has a positive NPV of $10,840 as per the following table
NPV Analysis
Year
Cash Flow
PV Factor @ 12%
PV
0
($126,000)
1
($126,000)
1
$42,518
0.8929
$37,962
2
$47,579
0.7972
$37,929
3
$85,629
0.7118
$60,949
NPV
$10,840
Year
0
1
2
3
After-Tax Savings
$28,600
$28,600
$28,600
Depreciation Tax Savings
$13,918
$18,979
$6,326
Net Cash Flow
$42,518
$47,579
$34,926
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