Capital Budgeting Exercise 1 You are considering the purchase of one of two mach
ID: 2701363 • Letter: C
Question
Capital Budgeting Exercise 1
You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $1000 initially, and then $300 per year in maintenance costs. Machine B costs $1300 initially, has a life of three years, and requires $200 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Which is the better machine for the firm? The discount rate is 8% and the tax rate is zero.
Year 0 1 2 3
Machine A%u2019s Cash Flows
Machine B%u2019s Cash Flows
Machine A%u2019s EAC
Machine B%u2019s EAC
Which machine do you choose?
Capital Budgeting Exercise 2
Your company has spent $400,000 on research to develop a new computer game. The firm is planning to spend $600,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine will be used for 3 years, has a $100,000 estimated resale value at the end of three years, and will be depreciated straight line over 4 years. Revenue from the new game is expected to be $800,000 per year, with costs of $300,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 8 percent, and it expects net working capital to increase by $150,000 at the beginning of the project. Should you proceed with this project? Explain.
Year 0 1 2 3
Sales
Fixed Costs
Depreciation
EBIT
Taxes
Net Income
Operating
Cash Flow
Change in NWC
Change
In Fixed Assets
Total
Cash Flow
Should you proceed with this project? Explain.
Explanation / Answer
1.
Year
0
1
2
3
Machine A%u2019s Cash Flows
-1000
-300
-300
-300
Machine B%u2019s Cash Flows
-1300
-200
-200
-200
Machine A%u2019s EAC
$380
Machine B%u2019s EAC
$304
I%u2019d choose Machine B. Although there is a higher initial cost the lower maintenance cost with the interest charges still make it cheaper on a year to year basis.
Year
0
1
2
3
Sales
0
800000
800000
800000
Fixed Costs
-400000
-300000
-300000
-300000
Depreciation
0
-162500
-162500
-162500
EBIT
0
337500
337500
337500
Taxes
0
118125
118125
118125
Net Income
-400000
219375
219375
219375
Operating
Cash Flow
-400000
-180625
38750
258125
Change in NWC
-400000
219375
219375
219375
Change
In Fixed Assets
650000
-162500
-162500
-162500
Total
Cash Flow
250000
56875
56875
56875
I would absolutely invest in this project with a near 25% ROI in three years its definitely worth the money risked.
Year
0
1
2
3
Machine A%u2019s Cash Flows
-1000
-300
-300
-300
Machine B%u2019s Cash Flows
-1300
-200
-200
-200
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