You are the head of finance department in XYZ Company. You are considering addin

Question

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 $10,900.00, and it would cost another $1,970.00 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 $2,150.00. The machine would require an increase in net working capital (inventory) of $680.00. The new machine would not change revenues, but it is expected to save the firm $33,085.00 per year in before-tax operating costs, mainly labor. XYZ's marginal tax rate is 32.00%.

1. If the project's cost of capital is 14.20%, what is the NPV of the project?

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

EXPLAIN ALL ANSWERS AND SHOW ALL WORK

Explanation / Answer

The total cost of the machine is $ ( 10,900 + 1970) = $ 12,870

Salvage value is $ 2,150. Therefore depreciable amount is $ 10,720

Tax

32%

1. The NPV of the project is $ 64,460

2. The initial outlay for the project is $ (12,870 + 680) = $ 13,550

3. The free cash flow for year 1 is (26,071 - 13,550) = $ 12,521

4.The additional cash flow for year 3 is $ ( 2150 x 0.68 + 680) =$ 2142

Period Initial cash outlay PV factor at 14.20% Saving in costs

Tax

32%

Depreciation Net cash inflows working caital plus salvage value Present value 0 12,870 1 (12,870) 0 680 1 (680) 1 0.9859 33,085 10,587 3,573 26,071 25703 2 0.9722 33,085 10,587 4,765 27,263 26,505 3 0.9586 33,085 10,587 1,588 24,086 2,830 25,802 NPV 64,460

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