You have been asked by the CFO of your company tp evaluate the proposed acquisit

Question

You have been asked by the CFO of your company tp evaluate the proposed acquisition of a new manufacturing machine. The machine's purchase price is $81,000 and it would cost another $12,500 to modify it so that it can be used by your firm. This machine which falls into the MACRS 5-year class, would be sold after 5 years. Use of the machine would require an increase in net working capital (more expensive raw materials) of $2,000. The machine would have no effect on revenues, but it is expected to save the firm $33,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 35%, and its required rate of return for such investments is 14%. Should the machine be purchased? Why or Why not?

Explanation / Answer

Initial Cost = 81000+12500+2000 = 95500 operational CF = 33000(1-0.35) * PVIFA(14%,5) = 21450 *3.43380 = 73655.01. Terminal Flow = 2000*0.51936 = 1038.737 NPV of machine = (95500) + 73655.01+ 1038.737 = -20806.26 Since machine has a negative value it should not be purchased

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