You must evaluate a proposal to buy a new milling machine. Thebase price is $108

Question

You must evaluate a proposal to buy a new milling machine. Thebase price is $108,000, and shipping and installation costs wouldadd another $12,500. The machine falls into the MACRS 3-year class,and it would be sold after 3 years for $65,000. The applicabledepreciation rates are 33,45,15, and 7 percent. The machine wouldrequire a $5,500 increase in working capital (increased inventoryless increased accounts payable). There would be no effect onrevenues, but pre-tax labor costs would decline by $44,000 peryear. The marginal tax rate is 35 percent, and the WACC is 12percent. Also, the firm spent $5,000 last year investigating thefeasibility of using the machine.

a.     How should the $5,000 spent last year behandled?

b.     What is the net cost of the machine forcapital budgeting purposes, that is, the year 0 project cashflow?

c.      What are the net operating cashflows during Years 1,2,and 3?

Explanation / Answer

$39,765.00

$54,225.00

Year 1

Year2

Year 3

(b)Calculating Net Cost of the Machine (or) "0" year Project Cashflow: Price of the Machine $108,000.00 Shipping & Installation Costs $12,500.00 Increase in Working Capital $5,500.00 Net Cost of the Machine (or) $126,000.00 Cashflows in "0" Year (c ) Calculating Net OperatingCash flows during the Years 1,2 &3: Net Operating Cash flows = Net Income +Depreciation Before Tax Labor costs the firm's savings $44,000per year After-Tax Savings ($44,000 *35%) $28,600.00 Calculating Depreciation Amount for each year: Depreciation in the year 1   ($120,500 *33%)

$39,765.00

($108,000 + $12,500 = $120,500) Depreciation in the Year 2 ($120,500 * 45%)

$54,225.00

Depreciation in the Year 3 ($120,500 * 15%) $18,075.00 Calculating Net Operating Cashflows:

Year 1

Year2

Year 3

After-Tax Revenues $28,600.00 $28,600.00 $28,600.00 Depreciation After tax (35%) $13,917.75 $18,978.75 $6,326.25 Net Operating Cash flows $42,517.75 $47,578.75 $34,926.25

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