Cash flows estimation and capital budgeting: You are the head of finance departm

Question

Cash flows estimation and capital budgeting: You are the head of finance department in XYZ Company. You are considering adding a new machine to your production facility. The new machine’s base price is $10,300.00, and it would cost another $2,540.00 to install it. The machine falls into the MACRS 3-year class (the applicable MACRS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%), and it would be sold after three years for $1,550.00. The machine would require an increase in net working capital (inventory) of $660.00. The new machine would not change revenues, but it is expected to save the firm $31,715.00 per year in before-tax operating costs, mainly labor. XYZ's marginal tax rate is 33.00%. If the project's cost of capital is 16.85%, what is the NPV of the project? Round your answer to two decimal places. For example, if your answer is $345.667 round as 345.67 and if your answer is .05718 or 5.718% round as 5.72.

Available answers: $12,840.00, $37,808.65, $10,300.00, $39,320.99, $23,132.49

Also, a. What is the initial cash outlay?
b. What are the free cash flow for year 1?
c. What is the additional Year-3 cash flow (i.e, the after-tax salvage and the return of working capital – also called terminal value)?

Explanation / Answer

Depreciation schedule and tax savings on depreciation

Realisation from sale of machine at the end of 3 years:

Book value = 12840 - 4279.57 - 5707.38 - 1901.6 = $ 951.45

Sale value = $1,550

Gain = $ 598.55

Tax on Gain = $ 598.55 * 33% = 197.52

Cashflow after tax = 1550 - 197.52 = $ 1352.48

cost reduction is to be taken only after tax because originally if the cost had been incurred what is expended is only the cost less tax savings so now when the cost is saved what is saved is the cost less the tax benifit only.

net cost saving = 31715 * (1-0.33) = 21,249.05

The net increse in working capital will amounts to cashoutflow and to be considered for NPV caluclation.

A. Initial cash outlay = 12840

B. free cashflow for year 1 = 22001.31

C. Additional year 3 cash 22569.06

The npv value may be differ from the answer because of assumption made in the answer but the nearest nvp is 37,808.05

year Depreciation Tax savings on depreciation @33% 1 (10,300+2540) * 33.33% =4279.57 1412.26 2 (10,300+2540) * 44.45% =5707.38 1883.43 3 (10,300+2540) * 14.81% =1901.60 627.528

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