P.D. Corporation is considering the purchase of a high-speed lathe that has an i
ID: 2729789 • Letter: P
Question
P.D. Corporation is considering the purchase of a high-speed lathe that has an invoice price of $250,000. The cost to ship the lathe to P.D.'s factory is $10,000, and the existing facilities will require modifications that are expected to cost $20,000. The machine will be depreciated on a straight-line basis over its useful life of 10 years, assuming no salvage value. P.D. Corporation is planning on paying for the lathe using a line of credit at the bank that has an interest rate of 6 percent per year. The lathe is expected to increase production and sales. Sales are expected to increase by $100,000 per year. Inventory and accounts receivable balances are expected to increase by $10,000 and $20,000 respectively. Expenses to operate the lathe are $25,000 per year. P.D.'s marginal tax rate is 40%.
a) calculate the initial outlay required to fund this project
b) calculate the incremental after-tax cash flow in year one of the project
Explanation / Answer
Part A
Initial outlay = cost of asset + shipping cost + installation and modification cost + net working capital
= 250,000 + 10,000 + 20,000 + (10,000 +20,000)
= 310,000
Part B
Annual depreciation = (capital cost – salvage value)/ life of the asset
= (250,000 +10,000 -0) / 10
= 26,000
Incremental after tax cash flow = (Revenue – expenses) x (1- tax rate) + depreciation x tax rate
= (100,000 -25,000) x (1-0.40) + 26,000 x 40%
= 45,000 + 10,400
= 55,400
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