1) Advanced Manufacturing is evaluating thhe prosposed acquisition of a new mili
ID: 2768317 • Letter: 1
Question
1) Advanced Manufacturing is evaluating thhe prosposed acquisition of a new miling machine. The machine's base price is $155,000, and it would cost another $12,800 to modifiy if for special use by your firm. The machine falls into the MACRS 5-year class, and it would be sold after 3 years for $65,000. The machine would require an increase in net operatring working capital (inventory) of $6,500. The milling machine would have no effect on revenues, but it is expected to save the firm $77,000 per year in before-tax operating costs mainly labor. Advanced's marginal tax rate is 35%. Advanced's cost of capital is 10%.
a. ) What is the cash flow for time period 0?
b.) What are the net operating cash flows in Years 1, 2 and 3
c.) What is the terminal cash flow? Show work
d.) Compute the NPV, Payback Period and MIRR for the project
e.) Should the project be accepted? Explain briefly
f.) Compute the IRR for the project using Excel
Explanation / Answer
Assuming the net working capital is returned after 3 years Year 0 Year 1 Year 2 Year 3 MACRS rate 20.00% 32.00% 19.20% Machine cost 167,800 Book Value after Year 3@28.8%= 48,326 Resale value 65,000 Capital Gain 16,674 Tax @35% on capital Gain 5,836 Cash Flow Details Year 0 Year 1 Year 2 Year 3 Investment in Machine (167,800) NWC (6,500) 6,500 Salvage 65,000 Pretax operating Cost Saving 77,000 77,000 77,000 Less Depreciation (33,560) (53,696) (32,218) Taxable Income 43,440 23,304 44,782 Tax @35% (15,204) (8,156) (15,674) Tax on Capital Gain (5,836) Post Tax Income (Including Salvage & NWC return) 28,236 15,148 94,773 Add back Depreciation 33,560 53,696 32,218 Net Cash flow (174,300) 61,796 68,844 126,990 PV factor @10% 1 0.9091 0.8264 0.7513 PV of Cash flows = (174,300) 56,178 56,896 95,410 NPV=Sum of PV of cash flows= $ 34,183.31 a Cash Flow Period 0= $ (174,300.00) Year 1 Year 2 Year 3 b Net Operating Cash flow Year 1,2,3 61,796 68,844 61,326 c Terminal Cash flow Yeart 3(NWC+Salvage less Tax on capital gain) NWC return 6,500 Salvage value 65,000 Less Tax on Capital Gain= (5,836) Terminal Cash flow year 3 $ 65,664.00 d NPV = $ 34,183.31 Payback in Years= 2.34 MIRR Year 1 Year 2 Year 3 Cash Inflows 61,796 68,844 126,990 Terminal Values @10% reinvestment= 74,773 75,728 126,990 Total Terminal Value of cash inflows= 277,491.28 Total Outflows PV = 174,300.00 MIRR = Nth Root ( Terminal Value/Investmnet)-1 3rd root (277491.28/174300)-1 MIRR =16.76% e The project is acceptable as NPV is positive, MIRR And IRR more than cost of capital. f IRR Calculation Cash Flow Details Year 0 Year 1 Year 2 Year 3 Investment in Machine (167,800) NWC (6,500) 6,500 Salvage 65,000 Pretax operating Cost Saving 77,000 77,000 77,000 Less Depreciation (33,560) (53,696) (32,218) Taxable Income 43,440 23,304 44,782 Tax @35% (15,204) (8,156) (15,674) Tax on Capital Gain (5,836) Post Tax Income (Including Salvage & NWC return) 28,236 15,148 94,773 Add back Depreciation 33,560 53,696 32,218 Net Cash flow (174,300) 61,796 68,844 126,990 PV factor @19.51% 1 0.8368 0.7002 0.5859 PV of Cash flows = (174,300) 51,708 48,201 74,397 NPV=Sum of PV of cash flows= $ 6.03 So IRR =19.51% as NPV is close to 0 at this rate .
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