You must evaluate a proposal to buy a new milling machine. The base price is $18
ID: 2776727 • Letter: Y
Question
You must evaluate a proposal to buy a new milling machine. The base price is $182, 000, and shipping and installation costs would add another $13,000. The machine falls into the MACRS 3-year class and it would be sold after 3 years for $91, 000. The applicable depreciation rates are 33%, 45%, 15% and 7%. The machine would require a $4, 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 $44,000 per year. The marginal tax rate in 35%, and the WACC is 10%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine. How should the $5,000 spent last year be handled? 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. Should the machine be purchased?Explanation / Answer
a)
Expenditure done In last year for feasibility analysis is sunk cost and should be ignored.
b)
Calculation of initial investment outlay:
Base Price
$ 182,000
Add: Shipping and installation costs
$ 13,000
Add: Increase in net working capital
$ 4,500
Initial investment outlay:
$ 199,500
c)
Calculation of Annual Cash Flows:
Year 1
Year 2
Year 3
Saving of post tax costs =44000*(1-35%) (A)
$ 28,600.00
$ 28,600.00
$ 28,600.00
Add: Saving of tax on depreciation
Depreciation = Cost * Dep %
$ 64,350.00
$ 87,750.00
$ 29,250.00
(195000*33%)
(195000*45%)
(195000*15%)
Saving of tax on depreciation = Dep * 35% (B)
$ 22,522.50
$ 30,712.50
$ 10,237.50
Sale value at the end =(Sale value -(Cost- Depreciation ))*(1-tax) (C
$ 50,277.50
(91000-(195000-181350))*(1-35%)
Annual cash Flows (A+B+C)
$ 51,122.50
$ 59,312.50
$ 89,115.00
d)
Evaluation of the Project: Using NPV
Year 0
Year 1
Year 2
Year 3
Initial investment outlay:
$ (199,500)
Annual Cash Flows
$ 51,122.50
$ 59,312.50
$ 89,115.00
Net cash Flows (CF)
$ (199,500)
$ 51,123
$ 59,313
$ 89,115
PVF (10%)
1.00000
0.90909
0.82645
0.75131
PV = CF*PVF
$ (199,500)
$ 46,475
$ 49,019
$ 66,953
NPV = Sum of PVs
$ (37,053)
Because NPV of the project is Negative hence it should not be accepted.
a)
Expenditure done In last year for feasibility analysis is sunk cost and should be ignored.
b)
Calculation of initial investment outlay:
Base Price
$ 182,000
Add: Shipping and installation costs
$ 13,000
Add: Increase in net working capital
$ 4,500
Initial investment outlay:
$ 199,500
c)
Calculation of Annual Cash Flows:
Year 1
Year 2
Year 3
Saving of post tax costs =44000*(1-35%) (A)
$ 28,600.00
$ 28,600.00
$ 28,600.00
Add: Saving of tax on depreciation
Depreciation = Cost * Dep %
$ 64,350.00
$ 87,750.00
$ 29,250.00
(195000*33%)
(195000*45%)
(195000*15%)
Saving of tax on depreciation = Dep * 35% (B)
$ 22,522.50
$ 30,712.50
$ 10,237.50
Sale value at the end =(Sale value -(Cost- Depreciation ))*(1-tax) (C
$ 50,277.50
(91000-(195000-181350))*(1-35%)
Annual cash Flows (A+B+C)
$ 51,122.50
$ 59,312.50
$ 89,115.00
d)
Evaluation of the Project: Using NPV
Year 0
Year 1
Year 2
Year 3
Initial investment outlay:
$ (199,500)
Annual Cash Flows
$ 51,122.50
$ 59,312.50
$ 89,115.00
Net cash Flows (CF)
$ (199,500)
$ 51,123
$ 59,313
$ 89,115
PVF (10%)
1.00000
0.90909
0.82645
0.75131
PV = CF*PVF
$ (199,500)
$ 46,475
$ 49,019
$ 66,953
NPV = Sum of PVs
$ (37,053)
Because NPV of the project is Negative hence it should not be accepted.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.