Garcia’s Truckin’ Inc. is considering the purchase of a new production machine f
ID: 2720255 • 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
a. Initial Outlay associated with the project:
b. Annual after tax cash flows:
c. Terminal Cash flow in year 10
d. NPV of the Machine:
The machine should be purchased due to positive NPV of $32442
$ Purchase Cost of the machine 200000 - Borrowing -100000 + Initial Training 5000 + Installation Cost 5000 Cost of the machine 110000 + Increase in Working Capital 20000 Total Initial Cash Outlay 130000Related Questions
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