. The Chung Chemical Corporation is considering the purchase of a chemical analy

Question

. The Chung Chemical Corporation is considering the purchase of a chemical analysis machine. Although the machine being considered will result in an increase in earnings before interest and taxes of $35,000 per year, it has a purchase price of $100,000, and it would cost an additional $5,000 to properly install the machine. In addition, to properly operate the machine, inventory must be increased by $5,000. This machine has an expected life of 10 years, after which it will have no salvage value. Also, assume simplified straight-line depreciation and that this machine is being depreciated down to zero, a 34% marginal tax rate, and a required rate of return of 15%. a. What is the initial outlay associated with this project? b. What are the annual after-tax cash flows associated with this project for years 1 through 9? c. What is the terminal cash flow in year 10 (what is the annual after-tax cash flow in year 10 plus any additional cash flows associated with the termination of the project)? d. Should this machine be purchased?

Explanation / Answer

Initial Investment =$ 100000+$5000+$5000 = $ 110000 Depreciation = ($ 100000+$5000)/10= $ 10500 Annual inflow before interest and tax= $ 35000 Discount rate = 15% Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Cash outlflw -110000 Cash inflow 35000 35000 35000 35000 35000 35000 35000 35000 35000 35000 Tax @ 34% -11900 -11900 -11900 -11900 -11900 -11900 -11900 -11900 -11900 -11900 Depreciation 10500 10500 10500 10500 10500 10500 10500 10500 10500 10500 Realease of Working capital 5000 -110000 33600 33600 33600 33600 33600 33600 33600 33600 33600 38600 Discount factor @ 15% 1           0.87           0.76           0.66           0.57           0.50           0.43           0.38           0.33           0.28           0.25 Discounted Cash flow                        -1,10,000      29,217      25,406      22,093      19,211      16,705      14,526      12,631      10,984         9,551         9,541      59,867 Net Present Value                              59,867 Project should be accepted as it has a Positive NPV.

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