You must evaluate a proposal to buy a new milling machine. The base price is $13
ID: 2721660 • Letter: Y
Question
You must evaluate a proposal to buy a new milling machine. The base price is $134,000, and shipping and installation costs would add another $16,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $60,300. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $4,000 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 $42,000 per year. The marginal tax rate is 35%, and the WACC is 14%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.
A. What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent.
$_____
B. What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent.
Year 1 $_____
Year 2 $_____
Year 3 $_____
Explanation / Answer
Depreciation Schedule
Year
Basis
%
Depreciation Expense
Accumulated Depreciation
Ending Book Value
1
$134,000.00
33.000%
$44,220.00
$44,220.00
$89,780.00
2
$134,000.00
45.000%
$60,300.00
$104,520.00
$29,480.00
3
$134,000.00
15.000%
$20,100.00
$124,620.00
$9,380.00
4
$134,000.00
7.000%
$9,380.00
$134,000.00
$0.00
Initial Investment = Base Price of Machine + Shipping & Installation Cost + Amount spent for investigation + Increase in Net Working Capital
So, Initial Investment = $134,000 + $16,000 + $5,000 + $4,000 = $159,000
After-tax salvage value of machine = Market Price – (Market price – Book value at the end of year 3 x tax rate)
=> $60,300 – [($60,300 - $9,380) x 0.35] = $42,478
Year
1
2
3
Pre-tax Savings
$42,000.00
$42,000.00
$42,000.00
Less: Depreciation
$44,220.00
$60,300.00
$20,100.00
Pre-tax Savings
-$2,220.00
-$18,300.00
$21,900.00
Less: Tax @ 35%
-$777.00
-$6,405.00
$7,665.00
After-tax Savings
-$2,997.00
-$24,705.00
$29,565.00
Add: Depreciation
$44,220.00
$60,300.00
$20,100.00
Add: Recovery of NWC
$0.00
$0.00
$4,000.00
Add: After-tax Salvage Value of Machine
$0.00
$0.00
$42,478.00
Net Operating Cash flow
$41,223.00
$35,595.00
$96,143.00
Depreciation Schedule
Year
Basis
%
Depreciation Expense
Accumulated Depreciation
Ending Book Value
1
$134,000.00
33.000%
$44,220.00
$44,220.00
$89,780.00
2
$134,000.00
45.000%
$60,300.00
$104,520.00
$29,480.00
3
$134,000.00
15.000%
$20,100.00
$124,620.00
$9,380.00
4
$134,000.00
7.000%
$9,380.00
$134,000.00
$0.00
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