Roten Manufacturing Company is considering an investment on a machine for produc

Question

Roten Manufacturing Company is considering an investment on a machine for producing auto parts. The machine costs $250,000 today, will have a five-year life and will be depreciated over a five-year life on a straight-line basis toward a zero salvage value. The company paid a consulting company $7,000 last year to help them decide whether there is a sufficient demand for the auto parts. In addition to the investment on the machine, the company also invests $15,000 in net working capital. The company has estimated the performance of the new machine and believes the following are good estimates of the new asset: sales $140,000 per year, cost of goods sold (35% of sales) per year, and administrative expenses $15,000 per year. The company pays interest $20,000 annually on average, has a 10% cost of capital and a 30% tax rate. Answer Questions 1 - 8.

QUESTION 1

Should Roten include consulting fee, $7,000, in estimating project's cash flows?

Yes

No

QUESTION 2

What is the project cash flow at Year 0?

-$250,000

-$15,000

-$265,000

-$203,000

QUESTION 3

What is the project cash flow at Year 5?

$74,000

$68,200

$50,500

$83,200

QUESTION 4

What is payback period for the project?

3.89 years

4.51 years

3.78 years

4.02 years

a.

Yes

b.

No

Explanation / Answer

1. No. Roten should not include consulting fees in cashflow calculation as it is a sunk cost.

2.c $265,000

265000

3. d.$83,200

4. a 3.89 years

Initial costs: Machine cost 250000 Investment in net working capital 15000 Total

265000

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