You have been asked by the president of your company to evaluate the proposed ac
ID: 2744950 • Letter: Y
Question
You have been asked by the president of your company to evaluate the proposed acquisition of a new machine. The company spent $10,000 to survey the market whether the new machine would be effective in production. The machine’s basic price is $50,000, and it will cost another $10,000 to install. The employees are supposed to obtain a training session before operating the machine, costing $4,000. The machine can be sold after four years for $8,000. Use of the machine will require an increase in account receivables by $5,000, a decrease in inventory by $4,000, and an increase in account payables by $12,000. The machine is expected to increase the sales revenue by $5,000, but it is expected to save the firm $10,000 per year in operating costs, mainly labor. To acquire this new machine, the firm would have to borrow $20,000 at 10% interest from its local bank, resulting in interest payments of $2,000 per year. The machine falls into the 4-year straight-line method for depreciation. The firm’s marginal tax rate is 34%. Assume the required rate of return is 10%.
(a) (5 points) What is the initial outlay associated with this project?Explain
(b) (4 points) What is the operating cash flow per year? Explain
(c) (4 points) What is the terminal cash flow? Explain
(d) (2 points) Find the NPV. Should the machine be purchased? Explain.
Explanation / Answer
(a)
Determine the initial outlay associated with this project:
Details
Amount
Basic price of machine
$ 50,000
Add: Installation cost
$ 10,000
Add: Training session of employees
$ 4,000
Initial outlay associated with project
$ 64,000
Explanation:
(b)
Compute the operating cash flow per year:
Corp.
Statement of cash flows (Indirect method)
For the period ended
Details
Amount
Amount
Net income ($10,000+$5,000)
$ 15,000
Adjustments for:
Add: Depreciation Expenses ($50,000+$10,000) / 4 years
$ 15,000
Increase in receivables
$ (5,000)
Decrease in inventory
$ 4,000
Increase in accounts payable
$ 12,000
Net cash provided (used) by operating activities
$ 41,000
Explanation:
(c )
Compute the terminal cash flow:
Terminal Cash Flow
= After-tax Proceeds from Disposal + Working Capital Recouped
= $8,000 (1-0.34) + $11,000Note
= $16,280
Note ($12,000 + $4,000-$5,000)
Explanation:
Working capital is taken as increase in Current assts –increase in current liabilities.
(d)
Find the NPV and should the machine be purchased:
Year
Cash flows
Discounting factor @ 10%
Discounted cash flows
0
$ (64,000)
1.000000
$ (64,000.00)
1
$ 39,000
0.909091
$ 35,454.55
2
$ 39,000
0.826446
$ 32,231.40
3
$ 39,000
0.751315
$ 29,301.28
4
$ 39,000
0.683013
$ 26,637.52
4
$ 5,280Note
0.680583
$ 3,593.48
NPV
$ 63,218.23
Note $8,000 (1-0.34)
Explanation:
Cash flows are taken as “cash flows from operating activities” – “Interest expenses” which $39,000 (i.e., $41,000-$2,000) per year.
As there is positive NPV, it is advisable to buy the machine.
Details
Amount
Basic price of machine
$ 50,000
Add: Installation cost
$ 10,000
Add: Training session of employees
$ 4,000
Initial outlay associated with project
$ 64,000
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.