4. Problem 12.09 Problem 12-9 New project analysis You must evaluate a proposal
ID: 2790465 • Letter: 4
Question
4. Problem 12.09
Problem 12-9
New project analysis
You must evaluate a proposal to buy a new milling machine. The base price is $145,000, and shipping and installation costs would add another $17,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $87,000. 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 $34,000 per year. The marginal tax rate is 35%, and the WACC is 10%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.
I.Last year's expenditure is considered an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.
II.Last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.
III.The cost of research is an incremental cash flow and should be included in the analysis.
IV. Only the tax effect of the research expenses should be included in the analysis.
V. Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay.
B. 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.
$
C. 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 $
D. Should the machine be purchased?
-Select-yesno
Problem 12-9
New project analysis
You must evaluate a proposal to buy a new milling machine. The base price is $145,000, and shipping and installation costs would add another $17,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $87,000. 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 $34,000 per year. The marginal tax rate is 35%, and the WACC is 10%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.
a. How should the $5,000 spent last year be handled? (Answer below I-VI.Last year's expenditure is considered an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.
II.Last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.
III.The cost of research is an incremental cash flow and should be included in the analysis.
IV. Only the tax effect of the research expenses should be included in the analysis.
V. Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay.
-Select-IIIIIIIVVItem 1
B. 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.
$
C. 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 $
D. Should the machine be purchased?
-Select-yesno
Explanation / Answer
Answer 1.
Last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.
Answer 2.
Initial Investment Inlay = Base Price of Machine + Installation Costs + Initial NWC required
Initial Investment Inlay = $145,000 + $17,000 + $5,500
Initial Investment Inlay = $167,500
Answer 3.
Value of Machine = Base Price of Machine + Installation Costs
Value of Machine = $145,000 + $17,000
Value of Machine = $162,000
Year 1:
Cost Saving = $34,000
Depreciation = $162,000 * 33%
Depreciation = $53,460
Net Cash Flow = Cost Saving*(1-tax) + tax*Depreciation
Net Cash Flow = $34,000*(1-0.35) + 0.35*$53,460
Net Cash Flow = $40,811
Year 2:
Cost Saving = $34,000
Depreciation = $162,000 * 45%
Depreciation = $72,900
Net Cash Flow = Cost Saving*(1-tax) + tax*Depreciation
Net Cash Flow = $34,000*(1-0.35) + 0.35*$72,900
Net Cash Flow = $47,615
Year 3:
Cost Saving = $34,000
Depreciation = $162,000 * 15%
Depreciation = $24,300
Book Value at the end of Year 3 = $162,000 - $53,460 - $72,900 - $24,300
Book Value at the end of Year 3 = $11,340
After-tax Salvage Value = Salvage Value - tax*(Salvage Value - Book Value)
After-tax Salvage Value = $87,000 - 0.35*($87,000 - $11,340)
After-tax Salvage Value = $60,519
Net Cash Flow = Cost Saving*(1-tax) + tax*Depreciation + After-tax Salvage Value + NWC recovered
Net Cash Flow = $34,000*(1-0.35) + 0.35*$24,300 + $60,519 + $5,500
Net Cash Flow = $96,624
Answer 4.
NPV = -$167,500 + $40,811/1.10 + $47,615/1.10^2 + $96,624/1.10^3
NPV = -$18,452.81
Yes, machine not be purchased.
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