You must evaluate a proposal to buy a new milling machine. the base price is $10

Question

You must evaluate a proposal to buy a new milling machine. the base price is $108,000, and shipping and installation costs would add another $12,500. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $65,000. the applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $5,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline buy $44,000 per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.

What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow?

Explanation / Answer

$5,000 spent by the firm last year investigating the feasibility of using the machine is a SUNK COST and will not form part of initial investment outlay for the machine for capital budgeting purposes,

..

The initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow = Base Price of the New Milling machine + Installation Cost + Increase in net operating working capital

= 108,000 + 12,500 + 5,500

= $126,000

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