Assume you are the owner and operator of a textile manufacturer. You must evalua

Question

Assume you are the owner and operator of a textile manufacturer. You must evaluate the proposal of buying a new machine for your factory. The company has already spent $5,000 investigating the feasibility of using the machine. The price of the equipment is $120,000. Shipping and installation will cost an additional $10,000. The machine falls under the MACRS 3- year class; the applicable depreciation rates are 33%, 45%, 15%, and 7%. After using the machine for three years it would be sold for $71,500. The machine would require an increase in net operating working capital of $6,000. The machine would not impact revenues, but it would cause pre-tax labor costs to decline by $42,500 per year. The marginal tax rate is 35% and the cost of capital is 11%.

a. How should the $5,000 spent on a feasibility analysis be handled?

b. What is the initial investment cost for the machine (Year 0 cash flow)?

c. What are the annual cash flows for years 1, 2 and 3?

d. Find the project’s NPV, IRR and MIRR.

e. Should you buy the machine? Explain your answer.

Explanation / Answer

1) As per General Accepted Standards and Indian Laws, all costs which necessitates to install and make an asset in working condition, shall be capitalised as Cost of the Asset ancilliary to.

So, 5000$ spent on feasibility study shall be capitalised along with the cost of new Machine.

2) Innitial Investment cost (Capitalised in Books as Asset) is :

As there is saving every year, so it would be recommended to buy the machine.

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