(New project analysis) The Chung Chemical Corporation is considering the purchas
ID: 2797431 • Letter: #
Question
(New project analysis) The Chung Chemical Corporation is considering the purchase of a chemical analysis machine. Although the machine being considered will result in an increase in earnings before interest and taxes of $32,000 per year, it has a purchase price of $100,000, and it would cost an additional $8,000 to properly install the machine. In addition, to properly operate the machine, inventory must be increased by $6,000. This machine has an expected life of 10 years, after which it will have no salvage value. Also, assume simplified straight-line depreciation and that this machine is being depreciated down to zero, a 35 percent marginal tax rate, and a required rate of return of 11 percent. a. What is the initial outlay associated with this project? b. What are the annual after-tax cash flows associated with this project for years 1 through 9? c. What is the terminal cash flow in year 10 (what is the annual after-tax cash flow in year 10 plus any additional cash flows associated with the termination of the project)? d. Should this machine be purchased?
Explanation / Answer
a) Initial Outlay for the project = $ 100,000(Cost of machine) + $ 8,000(Installation cost) + $6,000(Working capital for inventory)
= $ 114,000
b) Annual Cashinflows Year 1-9 = $ 24,580
*Depriciation = (Initial cost+ installation cost- salvage)/ no. of years
= {($100,000+$8,000)-0}/10
= $ 10,800
c) Terminal cashflows = Annual cashflows + Working capital for invetory surrendered
= $24,580+ $ 6,000
= $30,580
d) Calculation of NPV = P.V of cashinflows- P.V of cashoutflows
= (24,580*PVAF(11%,9) + 30,580* PVIF(11%,10) - ( 114000*1)
= 24580*5.537 + 30580*0.352 - 114000
=136099.46+10764.16-114000
=$ 32,863.62
Since NPV is positive, machine should be purchased.
Note: PVAF value can be taken from PVAF table or use do in calculator as 1/1.11 press = 9 times and then gross total button on calculator. For PVIF value use either PVIF table or in calculator press 1/1.11 press = 10 times the value that comes is PVIF.
Particulars Amount EBIT $32,000 - Depriciation* ($108,000/10) $10,800 EBT $21,200 -Taxes (35%) $7,420 EAT $13,780 Cashflows = EAT+Depriication $24,580Related Questions
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