Weir\'s Trucking, Inc, is considering the purchase of a new production machine f

Question

Weir's Trucking, Inc, is considering the purchase of a new production machine for $100, 000. The purchase of this new machine will result in an increase in earnings before interest and taxes of $25,000 per year. To operate this machine properly, workers would have to go through a brief training session that would cost $5,000 after tax. In addition, it would cost $5,000 after tax to install this machine correctly. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory of $25,000. This machine has an expected life of after which it will have no salvage value. Finally, to purchase the new machine if appears that the firm would have to borrow $80, 000 at 10 percent interest from Us local bank, resulting in additional interest payments of S8,(XX) per year. Assume! simplified straight-line depreciation, that this machine is being depreciated down to zero, a 34% marginal tax rate, and a required rate of return of 12%. What is the initial outlay associated with this project? What are the annual after-tax cash flows associated with this project for years 1 through 9? What is the terminal cash flow in year 10 (what is the annual after-tax cash flow in year 10 plus any additional cash flows associated with termination of the project)? should this machine be purchased?

Explanation / Answer

Part 1)

The initial outlay associated with the project is calculated with the use of following table:

_________

Part 2)

The annual after-tax cash flow for the years 1 to 9 is calculated with the use of following formula:

Notes:

1) Depreciation is calculated on the total cost of the machine and installation cost. Training cost will not be capitalized as only those costs which have been incurred to bring the asset to the present working condition will get treated as the cost of the asset.

2) Interest expenses are not considered in the calculation of operating cash flow.

________

Part 3)

The terminal year cash flow in Year 10 is calculated with as follows:

_________

Part 4)

To determine whether the machine should be purchased or not, we need to calculate the NPV (Net Present Value). NPV is the difference between the present value of cash inflows and cash outflows. The formula for calculating NPV is given below:

NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Required Return)^1 + Cash Flow Year 2/(1+Required Return)^2 + Cash Flow Year 3/(1+Required Return)^3 + Cash Flow Year 4/(1+Required Return)^4 + Cash Flow Year 5/(1+Required Return)^5 + Cash Flow Year 6/(1+Required Return)^6 + Cash Flow Year 7/(1+Required Return)^7 + Cash Flow Year 8/(1+Required Return)^8 + Cash Flow Year 9/(1+Required Return)^9 + Cash Flow Year 10/(1+Required Return)^10

_____

Using the values calculated above, we get,

NPV = -135,000 + 27,000/(1+12%)^1 + 27,000/(1+12%)^2 + 27,000/(1+12%)^3 + 27,000/(1+12%)^4 + 27,000/(1+12%)^5 + 27,000/(1+12%)^6 + 27,000/(1+12%)^7 + 27,000/(1+12%)^8 + 27,000/(1+12%)^9 + 52,000/(1+12%)^10 = $25,605.35

The machine should be purchased as it results in a positive NPV.

Cost of the Machine 100,000 Add Installation Cost 5,000 Training Cost 5,000 (One Time Cost) Increase in Working Capital 25,000 Total Initial Outlay $135,000 or -135,000

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