7. Problem 12.09 NEW PROJECT ANALYSIS You must evaluate a proposal to buy a new

Question

7. Problem 12.09 NEW PROJECT ANALYSIS You must evaluate a proposal to buy a new milling machine. The base price is $126,000, and shipping and installation costs would add another $18,000 The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $88,200. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $3,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $45,000 per year. The marginal tax rate is 35%, and the WACC is 11%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine a. How should the $5,000 spent last year be handled? I. Only the tax effect of the research expenses should be included in the analysis II. Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be III. Last year's expenditure is considered as an opportunity cost and does not represent an incremental cash flow. Hence, it should not be IV. Last year's expenditure is considered as a sunk cost and does not represent an incremental cash flow. Hence, it should not be included V. The cost of research is an incremental cash flow and should be included in the analysis included in the initial investment outlay included in the analysis. in the analysis Select- b. What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent. c. What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent. Do not round your intermediate calculations Year 1 S Year 2 9 Year 3 d. Should the machine be purchased? Select-

Explanation / Answer

a) IV is correct. It is a sunk cost.

b) Initial Investment = -147,500

c) Cash Flow = Profits + Depreciation + After-tax Salvage Value + NWC

d) As the NPV > 0, we should purchase the machine.

Machine 0 1 2 3 4 MACRS 33% 45% 15% 7% Investment -144,000 10080 NWC -3,500 3,500 Salvage 88,200 Savings 45,000 45,000 45,000 Depreciation -47520 -64800 -21600 EBT -2,520 -19,800 23,400 Tax (35%) 630 4950 -5850 Profits -1,890 -14,850 17,550 Cash Flows -147,500 45,630 49,950 103,508 NPV $9,832.81

Related Questions

Navigate

• Browse (All)
• Browse 7
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.