Greshak Corp. is considering a adding a new extruder machine that has an invoice
ID: 2728045 • Letter: G
Question
Greshak Corp. is considering a adding a new extruder machine that has an invoice price of $825,000 and is expected to cost an additional $25,000 to install. The new machine is much more efficient than the current machine used by the company and will increase the company's revenues by $300,000 per year. However, the machine also is more expensive to operate and will result in additional labor costs of $30,000 and electricity costs of $10,000. In addition, the new machine will reduce scrap costs by $5,000 per year due to its enhanced technology. Based on management's estimates, the new machine would require the company to incur an additional investment in working capital of $28,000 initially, but it would be recovered at the end of the project’s 5 year life. Greshak would use the 3-year MACRS method to depreciate the machine, and management thinks the machine would have a value of $50,000 at the end of its 5 year operating life. The applicable depreciation rates are 33.33%, 44.45%, 14.81%, and 7.42% per the U.S. tax code. Assume that Greshak's marginal tax rate is 40%, and a 12% WACC is applicable for the project.
Based on the data presented, what is the Year 2 relevant net cash flow? YOU MUST SHOW ALL WORK TO RECEIVE CREDIT!
Explanation / Answer
MACRS depreciation for year 2 = cost of asset x MACRS rate
=825000 x 44.45%
= 366,712.50
Depreciation Tax Shield = 366,712.50 x 40%
= 146,685
EBIT = 300,000 – 30,000 -10,000 +5000
= 265000
Year 2 cash flow= EBIT x (1-t) + Depreciation tax shield
= 265,000 x (1-0.40) + 146,685
= 305,685
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