Calculating project cash flows and NPV) Raymobile Motors is considering the purc

Question

Calculating project cash flows and NPV) Raymobile Motors is considering the purchase of a new production machine for $500, 000. The purchase of this machine will result in an increase in earnings before interest and taxes of SI 50, 000 per year. To operate this machine properly, workers would have to go through a brief training session that would cost $25,000 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 $30, 000. This machine has an expected life of 10 years, after which it will have no salvage value. Assume simplified straight -line depreciation, that this machine is being depreciated down to zero, a 347c marginal tax rate, and a required rate of return of 15%. What is the initial outlay associated with this project? What are the annual after-tax cash flows associated with this project for year 1 through 9? What is the terminal cash flow in year 10 (what is the annual after-tax cash flow year 10 plus any additional cash flows associated with termination of the project)? Should this machine be purchased?

Explanation / Answer

a) Initial outlay of cash = 500,000 + 5,000 + 30,000 + 25,000 = $560,000

b)
Annual tax savings on depreciation: Basis $505,000 / 10 = 50,500 * 34% = $17,170
Annual cash flow: 150,000 less 34% tax = $99,000
Total $116,170

c)
Total we calculated in b) $116,170 + $30,000 = $146,170

d)
Initial Investment = ($560,000)
PV Annuity of 116,170, N 9, R 15% = $554,315
PV 146,170, N 10, R 15% = $36,131
NPV $30,446 Positive

As the NPV shows a positive result, the Machine can be purchased

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