You must evaluate a proposal to buy a new milling machine. The base price is $13

Question

You must evaluate a proposal to buy a new milling machine. The base price is $130,000, and shipping and installation costs would add another $7,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $78,000. 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 $56,000 per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.

What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent.
$  

What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent.

Year 1

Year 2

Year 3

Explanation / Answer

Answer: The initial project cash flow (cost) can be determined as:

Answer: The operating cash flows of the project can be worked out as:

The $5,000 spent last year on exploring the feasibility of the project is a sunk cost and should not be included in the analysis

The terminal cash flow is $63556

Salvage value = $78,000

Tax on SV* = (19,798)

Return of NOWC = 9,500

$78.000 - $23944 + $9,500 = $63556

*Tax on SV = ($78,000 – $9590)(0.35) = $23944

BV in Year 4 = $137000(0.07) = $9590

Purchase Price -130000 Shipping and installation costs -7000 Increase in net working capital -9500 -146500

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