You must evaluate a proposal to buy a new milling machine. The base price is $12

Question

You must evaluate a proposal to buy a new milling machine. The base price is $128,000, and shipping and installation costs would add another $20,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $83,200. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $9,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $52,000 per year. The marginal tax rate is 35%, and the WACC is 14%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine. What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent.

Please show all calculations.

Explanation / Answer

The $5,000 spent on investigating the feasibility of using the machine is a sunk cost and cannot be considered in the analysis.

The salavage value of the project is calculated as follows

Sale value = 83,200

Book value = 7% of 83,200 = 0.07 * 128000 = 8960

Taxable value = 83,200 - 8960 = 74,240

Tax at 35% = 0.35 * 74,240 = 25,984

After tax salavage value = 83,200 - 25,984 = 57,216

This value is used in the analysis

The Cash flows are calculated as follows:

Year 0 1 2 3 Initial Investment -128000 Installation cost -20000 Increase in Working Capital -9500 Cost Savings 52000 52000 52000 Depreciation 42240 57600 19200 Profit after tax 9760 -5600 32800 Tax at 35% 3416 0 11480 Net Income 6344 -5600 21320 Add back depreciation 42240 57600 19200 Return of Working capital 9500 After tax salavage value 57216 Net Cash flow 48,584 52,000 107,236

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