Acme Toy Company is considering the purchase of a machine for their production l

Question

Acme Toy Company is considering the purchase of a machine for their production line.

Information on the purchase is shown below. show working in xl

a. Calculate the initial outlay associated with the project.

b. What is the annual after tax cash flows for years 1-9?

c. What is the terminal cash flow in year 10?

d. Should the machine be purchased? (Do an NPV)

Purchase Information: 1. Cost of machine is $ 3000000 2. Expected increase in EBIT is $ 700000 3. Training costs for new machine $ 225000 4. Increase in inventory for new parts $ 375000 5. Salvage value of machine $ 300000 6. Expected life of machine - 10 years, use straight line depreciation. 7. Tax Rate - 35% 35% 8. Required Rate of Return 12%

Explanation / Answer

a) Initial Outlay = Machine Cost + Inventory + Training = $3,600,000

b) Operating cash flows = Operating Profits + Depreciation = EBIT x (1 - tax) + Investment / No. of years

= 700,000 x (1 - 35%) + 3,000,000 / 10

= 755,000

c) Terminal Cash Flow = Operating Cash Flow + Working Capital + After-tax salvage value

= 755,000 + 375,000 + 300,000 x (1 - 35%)

= 1,325,000

d) In excel, NPV = NPV(12%, 755000....1325000) - 3600000 = $849,443.13

As the NPV >0, the machine should be purchased.

Acme 0 1 2 3 4 5 6 7 8 9 10 Investment -$   3,000,000 Inventory -$      375,000 $    375,000 Training -$      225,000 Salvage $    300,000 EBIT $ 700,000 $     700,000 $      700,000 $   700,000 $700,000 $ 700,000 $ 700,000 $    700,000 $    700,000 $    700,000 Tax (35%) $ 245,000 $     245,000 $      245,000 $   245,000 $245,000 $ 245,000 $ 245,000 $    245,000 $    245,000 $    245,000 Operating Profits $ 455,000 $     455,000 $      455,000 $   455,000 $455,000 $ 455,000 $ 455,000 $    455,000 $    455,000 $    455,000 Depreciation $ 300,000 $     300,000 $      300,000 $   300,000 $300,000 $ 300,000 $ 300,000 $    300,000 $    300,000 $    300,000 Cash Flows -$   3,600,000 $ 755,000 $     755,000 $      755,000 $   755,000 $755,000 $ 755,000 $ 755,000 $    755,000 $    755,000 $ 1,325,000 NPV $849,443.13

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