You must evaluate a proposal to buy a new milling machine. The base price is $11

Question

You must evaluate a proposal to buy a new milling machine. The base price is $118,000, and shipping and installation costs would add another $6,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $76,700. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $7,500 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 $52,000 per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.

Explanation / Answer

Last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.

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