4. Jivanka Industries is considering purchasing a new milling machine from Russi

Question

4. Jivanka Industries is considering purchasing a new milling machine from Russia that costs $100,000. The machine's installation and shipping costs will total $20,000. If accepted, the milling machine project will require an initial net working capital investment of S30,000 (all working capital will be returned at the end of the project). Jivanka plans to fully depreciate the machine on a straight-line basis over a period of eight years (the length of the project). An additional working capital investment of $10,000 will need to be made during year 3. The new milling machine will allow for incremental revenue of $60,000 in year 1, growing 8% (compounded) for the length of the project. This extra revenue will require extra expenses (excluding depreciation) of S30,000 in year 1, growing 5% (compounded) for the length of the project. The firm's marginal tax rate is 40%. At the end of the project the milling machine will be sold for 00 aulate the t er-ds s ows ofthe projet for each yeu.

Explanation / Answer

Net investment in year0= 150000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Initial investment              (120,000) Working capial outflow                (30,000) Annual cash flows: Revenue                60,000                64,800                69,984                75,583                81,629                88,160                95,212              102,829 Expenses              (30,000)              (31,500)              (33,075)              (34,729)              (36,465)              (38,288)              (40,203)              (42,213) Depreciation              (15,000)              (15,000)              (15,000)              (15,000)              (15,000)              (15,000)              (15,000)              (15,000) Profit before tax                15,000                18,300                21,909                25,854                30,164                34,871                40,010                45,616 Tax@ 40%                (6,000)                (7,320)                (8,764)              (10,342)              (12,066)              (13,948)              (16,004)              (18,247) Profit after tax                  9,000                10,980                13,145                15,512                18,098                20,923                24,006                27,370 Add: Depreciation                15,000                15,000                15,000                15,000                15,000                15,000                15,000                15,000 Cash flow after tax                24,000                25,980                28,145                30,512                33,098                35,923                39,006                42,370 Additional working capital              (10,000) Net cash flow                24,000                25,980                18,145                30,512                33,098                35,923                39,006                42,370 Salvage value                40,000 Working capital recovery                40,000 Net cash flow              (150,000)                24,000                25,980                18,145                30,512                33,098                35,923                39,006              122,370

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