Mars Inc. is considering the purchase of a new machine that costs $80,000. This

Question

Mars Inc. is considering the purchase of a new machine that costs $80,000. This machine will reduce manufacturing costs by $20,000 annually. Mars will use the 3-year MACRS method (shown below) to depreciate the machine, and it expects to sell the machine at the end of its 5-year life for $10,000 salvage value. The firm expects to be able to reduce net operating working capital by $8,000 when the machine is installed, but the net working capital will return to the original level when the project is over (i.e., after 5 years). Mars's marginal tax rate is 40 percent, and it uses a 12 percent cost of capital to evaluate projects of this nature. Calculate the net cash flows of the project. Cash outflows should be negative numbers, and round it to a whole number, e.g., -23,500.

Year MACRS % 1 0.33 2 0.45 3 0.15 4 0.07 5 0.11 6 0.06

Explanation / Answer

Calculation of Net Cash Flows of the Project :

Initial Investment = Purchase price of machine - Reduction of Working Capital = 80000-8000 = $72000

Cash Flows per year = Savings in Cost (Net of Tax) + Tax Saving on Depreciation

Depreciation per year

Cash Flows in the end of 5 years = 10000- Tax on Scrap = $10000

Note: Tax on Scrap will be Nil as the book value of $20741 is more than its scrap value of $10000

48000+10000 = 58000

Year Cost/Opening WDV Dep Tax Savings WDV 1 80000 26400 10560 53600 2 53600 24120 9648 29480 3 29480 4422 1769 25058 4 25058 1754 702 23304 5 23304 2563 1025 20741 6 20741 1244 498 19497

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