The Stanley Construction Company is contemplating the purchase of a new earth mo

Question

The Stanley Construction Company is contemplating the purchase of a new earth mover. The mover%u2019s basic price is $50,000, and it would cost another $10,000 to modify it for special use. Assume that the mover falls into the MACRS 3-year class; it would be sold after 3 years for $20,000; and it would require an increase

in net working capital (spare parts inventory) of $2,000. The earth mover would have no effect on revenue, but is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The company's marginal federal-plus-state tax rate is 40%. Utilize the following MACRS rates for depreciation expense:

Year               Depreciation Rate

1                              33%

2                              45

3                              15

                                                     4                               7

1. What is the net cost of the earth mover?

2. What are the operating cash flows in years 1,2, & 3?

3. What are the additional (non-operating) cash flows in year 3?

4. If the project's cost of capital is 10%, should the earth mover be purchased?

***Note: Please show work so I can make sure I understand.

Explanation / Answer

4. If the project's cost of capital is 10%, should the earth mover be purchased?

NPV= -62000+ 19920/(1.10)+22800/(1.10)^1+ 31280/(1.10)^2

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=-62000+18109+18843+23501=-1547()negative)

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