1- Coffee Shop is considering a three-year project to purchase a new machine pre

Question

1-     Coffee Shop is considering a three-year project to purchase a new machine press to improve its production efficiency. Six months ago, it contracted with Dr. right to provide a thorough study of whether there was a need for this three-year efficiency project. The report was delivered one month ago and it’s cost was $25,000. The report suggests that the company should go ahead with the project subject to Massey’s financial analysis. Buying a new machine press for $400,000 is estimated to result in $120,000 in annual pretax cost savings. The press falls in the MACRS five-year class and it will have a salvage value at the end of the project of $85,000. At time 0, the press will also require an additional investment in inventory of $9,000. Other current accounts will not be affected. If the company’s tax rate is 40% and its WACC is 10%, determine the company’s free cash flow for each year (i.e. from time 0 to time 3)?    The MACRS schedule is as follows:

Year

5-year Class

1

20%

2

32%

3

19.2%

4

11.52%

5

11.52%

6

5.76%

Year

5-year Class

1

20%

2

32%

3

19.2%

4

11.52%

5

11.52%

6

5.76%

Explanation / Answer

Free cash flow calculation is as per Excel sheet

Year 0 1 2 3 Initial Investment 400000 Additional inventory 9000 Report cost 25000 Pretax Cost Savings 120000 120000 120000 Depreciation MACRS Rates 20% 32% 19.20% Depreciation = Depreciation rate * Initial Investment 80000 128000 76800 EBIT= After tax Cost savings - Depreciation 40000 -8000 43200 Tax = Tax rate * EBIT 16000 -3200 17280 EAT= EBIT-TAXES 24000 -4800 25920 Depreciation 80000 128000 76800 after tax salvage value= salvage value* ( 1 -tax rate) 51000 Free cash flow= EAT + Depreciation + After tax Salavge value -434000 104000 123200 153720

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