(New project analysis) Garcia\'s Truckin\' Inc. is considering the purchase of a

Question

(New project analysis) Garcia's Truckin' Inc. is considering the purchase of a new production machine for $150,000. The purchase of this machine will result in an increase in earnings before interest and taxes of $80,000 per year. To operate the machine properly, workers would have to go through a brief training session that would cost $5,000 after taxes. It would cost $4,000 to install the machine properly. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory of $30,000. This machine has an expected life of 10 years, after which it will have no salvage value. Finally, to purchase the new machine, it appears that the firm would have to borrow $100,000 at 12 percent interest from its local bank, resulting in additional interest payments of $12,000 per year. Assume simplified straight-line depreciation and that the machine is being depreciated down to zero, a 33 percent marginal tax rate, and a required rate of return of 14 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 the machine be purchased?

Explanation / Answer

1 Initial Investment - Cost of machine 150000 Training Cost 5000 Installation cost 4000 Increase in Net Working capital - Increase in Inventory 30000 189000 2 Calculation of Annual operating cash flows Incremental EBIT 80000 Less: Interest expenses (100000 x 12%) 12000 EBT 68000 Less Tax @ 35% 22440 PAT (4m/5) 45560 Add: Depreciation (154000/10) 15400 OCF 60960 3 Terminal cash flows Post tax salvage value 0 Recovery of NWC 30000 30000 4 NPV - 0 1 to 9 10 Initial Investments -189000 OCF 60960 60960 Terminal Cash flows 30000 Net Cash flows -189000 60960 90960 PV factors @ 14% 1 4.9464 0.269744 PV of cash flows -189000 301530.8 24535.9 NPV = 137066.7 Project is acceptable as it has a positive NPV. Please provide feedback…. Thanks in advance…. :-)

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