The Marchal Company is evaluating the proposed acquisition of a new machine. The

Question

The Marchal Company is evaluating the proposed acquisition of a new machine. The machine's base price is $250,000, and it would cost another $15,000 to modify it for special use. The machine falls into the MACRS 3-year class, and it would be sold after 2 years for $75,000. The machine would require an increase in net working capital of $5,000. The machine would have no effect on revenues, but it is expected to save the firm $100,000 per year for 2 years in before-tax operating costs.   Campbell's marginal tax rate is 30 percent and its cost of capital is 10 percent.

a. Calculate the cash outflow at time zero.

b. Calculate the net operating cash flows for Years 1 and 2.

c. Calculate the non-operating terminal year cash flow.

Cost of capital

a. Calculate the cash outflow at time zero.

b. Calculate the net operating cash flows for Years 1 and 2.

c. Calculate the non-operating terminal year cash flow.

Cost of capital

Explanation / Answer

Year 1 = 0.3333 * 250000 = $83325

Year 2 = 0.4445 * 250000 = $111125

The firm saves $100000 per year before tax

Thus increase in inflow in Year 1= 100000*(1-0.3) + 0.3*83325 = $94997.5

Thus increase in inflow in Year 1 = 100000*(1-0.3) + 0.3*111125 = $103337.5

3. Salvage value = $75000

Book value at end of year 2 = 250000 – 83325 – 111125 = $55550

Terminal year cash flows ( inflows) = 75000 + 5000 – 0.3(75000 – 55550) = $74165

4. Net present value at 10% cost of capita = -270000 + 86361.36 + 146696.28 = $-36942.36

Since NPV is negative the machinery should not be purchased

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