Weir\'s Trucking, Inc. is considering the purchase of a new production machine f
ID: 2718762 • Letter: W
Question
Weir's Trucking, Inc. is considering the purchase of a new production machine for $105,000. The purchase of this new machine will result in an increase in earnings before interest and taxes of $23,000 per year. To operate this machine properly, workers would have to go through a brief training session that would cost $5,500 after tax. In addition, it would cost $5,500 after tax to install this machine correctly. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory of $22,000. 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 $50,000 at 10 percent interest from its local bank, resulting in additional interest payments of $5,000 per year. Assume simplified straight-line depreciation, that this machine is being depreciated down to zero, a 33 percent marginal tax rate, and a required rate of return of 8 percent. What is the initial outlay associated with this project? What are the annual after-tax cash flows associated with this project for years 1 through 9? What is the terminal cash flow in year 10 (that is, the annual after-tax cash flow in year 10 plus any additional cash flows associated with termination of the project)? Should this machine be purchased? Garcia's Truckin', Inc. is considering the purchase of a new production machine for $190,000. The purchase of this machine will result in an increase in earnings before interest and taxes of $40,000 per year. To operate this machine properly, workers would have to go through a brief training session that would cost $4,500 after tax. In addition, it would cost $4,500 after tax to install this machine correctly. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory of $27,000. 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 $60,000 at 8 percent interest from its local bank, resulting in additional interest payments of $4,800 per year. Assume simplified straight-line depreciation, that this machine is being depreciated down to zero, a 32 percent tax rate, and a required rate of return of 13 percent. What is the initial outlay associated with this project? What are the annual after-tax cash flows associated with this project for years 1 through 9? What is the terminal cash flow in year 10 (that is, the annual after-tax cash flow in year 10 plus any additional cash flows associated with termination of the project)? Should this machine be purchased?Explanation / Answer
1) Year 0 1 Purchase price (105,000) installation (5,500) Training cost (5,500) increase in earnings 23,000 Interest cost (5,000) depreciation (11,050) net earning before tax 6,950 Tax 33% (2,294) earning after tax 4,657 depreciation 11,050 Cash flow (116,000) 15,707 initial outlay (116,000) cash flow 1 to 10 15,707 Annuity factor at 8% for 10 yrs 6.7101 Total cashinflow 105,392 NPV of machine (10,608) since NPV is negative the machine should not be purchased Note1 Depreciation cost (110,500) useful life 10 Depreciation (11,050) 2) Year 0 1 Purchase price (190,000) installation (4,500) Training cost (4,500) increase in earnings 40,000 Interest cost (4,800) depreciation (19,450) net earning before tax 15,750 Tax 32% (5,040) earnings after tax 10,710 depreciation 19,450 Cash flow 30,160 initial outlay (199,000) cash flow 1 to 10 30,160 Annuity factor at 13% for 10 yrs 5.4262 Total cashinflow 163,654 NPV of machine (35,346) since NPV is negative the machine should not be purchased Note1 Depreciation cost (194,500) useful life 10 Depreciation (19,450)
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