Garcia’s Truckin’ Inc. is considering the purchase of a new production machine f
ID: 2716070 • Letter: G
Question
Garcia’s Truckin’ Inc. is considering the purchase of a new production machine for $200,000. The purchase of this machine will result in an increase in earnings before interest and taxes of $50,000 per year. To operate this machine properly, workers would have to go through a brief training session that would cost $5,000 after tax. In addition, it would cost $5,000 after tax to install this machine properly. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory of $20,000. This machine has an expected life of 10 years, after which it will have no salvage value. Finally, to purchase the new machine, it appears that the firm would have to borrow $100,000 at 8 percent interest from its local banks, resulting in additional interest payments of $8,000 per year. Assume simplified straight-line depreciation and that this machine is being depreciated down to zero, a 34 percent marginal tax, and a required rate of return of 10 percent.
(a) What is the initial outlay associated with this project?
(b) What are the annual after-tax cash flows associated with this project for years 1 through 9?
(c) What is the terminal cash flow in year 10 (what is the annual after-tax cash flow in year 10 plus any additional cash flows associated with termination of the project)?
(d) Should the machine be purchased?
Explanation / Answer
AsNPV is negative the machine should not be purchased
Cost of machine 200,000 training 5,000 installation 5,000 inventory 20,000 Initial outlay 230,000 Year Initial outlay Depreciation Interest payments saving profit tax @ 34% after tax Tax benefit on depreciation Cash flow PV@10% 0 230,000 (230,000) 1 20,000 8,000 50,000 22,000 7,480 14,520 6,800 21,320 19,381.82 2 20,000 8,000 50,000 22,000 7,480 14,520 6,800 21,320 17,619.83 3 20,000 8,000 50,000 22,000 7,480 14,520 6,800 21,320 16,018.03 4 20,000 8,000 50,000 22,000 7,480 14,520 6,800 21,320 14,561.85 5 20,000 8,000 50,000 22,000 7,480 14,520 6,800 21,320 13,238.04 6 20,000 8,000 50,000 22,000 7,480 14,520 6,800 21,320 12,034.58 7 20,000 8,000 50,000 22,000 7,480 14,520 6,800 21,320 10,940.53 8 20,000 8,000 50,000 22,000 7,480 14,520 6,800 21,320 9,945.94 9 20,000 8,000 50,000 22,000 7,480 14,520 6,800 21,320 9,041.76 10 20,000 8,000 50,000 22,000 7,480 14,520 6,800 21,320 8,219.78 NPV (98,998)Related Questions
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