You must evaluate a proposal to buy a new milling machine. The base price is $19

Question

You must evaluate a proposal to buy a new milling machine. The base price is $191,000, and shipping and installation costs would add another $13,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $95,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $10,000 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 by $49,000 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.

a) What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent.

b) What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent.

Explanation / Answer

1) Net Cost of the machine = $191000 + $13000 + $10000 = $ 214000 2) Year 1 2 3 After-Tax Savings $31,850 $31,850 $31,850 Depreciation Tax Savings $23,562 $32,130 $10,710 Net Cash Flow $55,412 $63,980 $42,560 After-tax cost savings is $49000 (1 – T) = $49,000(0.65) = $31850 The depreciation expense in each year is the depreciable basis, ( $191000+13000)= 204000 times the MACRS allowance percentages of 0.33, 0.45, and 0.15 for Years 1, 2, and 3, respectively. Depreciation expense in Years 1, 2, and 3 is $67320 , $91800, and $30600. The depreciation tax savings is calculated as the tax rate (35%) times the depreciation expense in each year

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