\"Wilson Machine Tools is considering a high-tech computer-controlled milling ma

Question

"Wilson Machine Tools is considering a high-tech computer-controlled milling machine at a cost of $93,000. The cost of installing the machine, preparing the site, wiring, and rearranging other equipment is expected to be $15,000. This installation cost will be added to the cost of the machine to determine the total cost basis ($108,000) for depreciation. The milling machine is expected to last 6 years. The machine is classified as a seven-year MACRS property. The milling machine will have a $16,000 salvage value at the end of 6 years.

Special jigs and tool dies for the milling machine also will be required at a cost of $11,000, and the jigs and dies last only 3 years. Therefore, another set of jigs and dies has to be purchased at the end of year 3, so you should also include the purchase of jigs and dies as another investment in year 3. There is no salvage or disposal cost for the jigs and dies. The jigs and dies are classified as a three-year MACRS property, and you need to depreciate them twice (the first time through years 1 through 3 and the second time in years 4 through 6). Since the jigs and dies have no salvage value but will not be fully depreciated at the end of year 3 and year 6, Wilson will receive a tax refund for the jigs and dies. It will be easier to have separate rows for depreciating the milling machine and depreciating the jigs and dies.

With the new milling machine, Wilson expects an additional annual revenue of $89,000 due to increased production. The additional annual production costs are estimated as follows: materials, $7,700; labor $14,000; energy $6,200; and miscellaneous O&M costs $4,000. Wilson s marginal income-tax rate is expected to remain at 33% over the project life of 6 years.

All dollar figures given above represent today's (constant) dollars. The expected general inflation rate during the project period is estimated at 3.1%, which applies to the revenue, the expenses (materials, labor, energy, O&M), the salvage value, and the cost of purchasing the jigs and dies at the end of 3 years. If Wilson's inflation-free interest rate (MARR') is 18.3%, calculate the net present worth of the cash flow for the computer-controlled milling machine project after accounting for inflation."

Explanation / Answer

Step 1) Initial investment

=Cost of machine+ cost of installation+ cost of jigs

=93000+15000 +11000

=119000$

Step 2) depriciation

For machine

For Jigs

For jigs to be purchase at year 0

For jigs to be purchased at end of year 3

Vlau of jigs

=11000*(1+ inflation rate)^n

=11000(1+0.031)^3

=11000(1.031)^3

=12055$

Statement showing values of revenue , total expenses and scrap value after inflation

For revenue

Total expense

Salvage value = 16000*(1.031)^6 = 19216.4$

Statement showing NPV

WN-1)

Nominal rate = (1+Real rate )*(1+inflation rate)

=(1.183)*(1.031) - 1

=1.219673-1

=21.67%

Year Operning balance Depriciation rate Depreciation Closing value 1 108000 14.29% 15433 92567 2 92567 24.49% 26449 66118 3 66118 17.49% 18889 47228 4 47228 12.49% 13489 33739 5 33739 8.93% 9644 24095 6 24095 8.92% 9634 14461

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