Dayman Inc. has asked you to evaluate a proposal to buy a new costume machine. T

Question

Dayman Inc. has asked you to evaluate a proposal to buy a new costume machine. The base price is $110,000, and shipping and installation costs would add another $15,000. The machine falls into the MACRS 3-year class, and it would be sold after another 3 years for $65,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $5,500 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 $49,000 per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $15,000 last year investigating the feasibility of using the machine. What are the project’s cash flows at year 1 (1 point) and year 2 (1 point)?

Explanation / Answer

The net cost of the machine is $145500

Price $110000

Installation Cost 15000

Feasibility Cost 15000

Increase in Working Capital 5500

145500

1 2 3

1 After Tax saving $31850 $31850 $31850

2 Depreciation Tax Saving 16170 22050 7350

Net Cash Flow 15680 9800 24500

Notes-

1.   The after-tax cost savings is $49,000(1 - T) = $49,000(0.65)1.   The after-tax cost savings is $49,000(1 - T) = $44,000(0.65)1.   The after-tax cost savings is $49,000(1 - T) = $49,000(0.65)

2.   The depreciation expense in each year is the depreciable basis, $140,000, times the MACRS allowance percentages of 0.33, 0.45, and 0.15 for Years 1, 2, and 3, respectively. Depreciation expense in Years 1, 2, and 3 is $46200, $63000, and $21000. The depreciation tax savings is calculated as the tax rate (35%) times the depreciation expense in each year.

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