New project analysis You must evaluate a proposal to buy a new milling machine.
ID: 2721781 • Letter: N
Question
New project analysis
You must evaluate a proposal to buy a new milling machine. The base price is $197,000, and shipping and installation costs would add another $8,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $137,900. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $8,500 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 $60,000 per year. The marginal tax rate is 35%, and the WACC is 13%. 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.
Explanation / Answer
Answer 1 Initial investment outlay for the machine in Year 0 = Cost of the machine + shipping & Installation cost + Increase in net operating working capital Initial investment outlay for the machine in Year 0 = $197000 + $8000 + $8500 = $213500 Answer 2 Cost of machine = $197000 + $8000 = $205000 Depreciation under MACRS 3 Year Class Year Rate Depreciation 1 33% $67,650 2 45% $92,250 3 15% $30,750 Calculation project annul cash flows Year cash inflow (saving in labour cost) Depreciation Net increase in net income Tax @ 35% Increase in profit after tax Salvage value Feasibility study exp Net Cash Inflow A B C = A - B D = C * 0.35 E = C - D F G E + B + F - G 1 $60,000.00 $67,650.00 -$7,650.00 -$2,677.50 -$4,972.50 $62,677.50 2 $60,000.00 $92,250.00 -$32,250.00 -$11,287.50 -$20,962.50 $71,287.50 3 $60,000.00 $30,750.00 $29,250.00 $10,237.50 $19,012.50 $1,37,900.00 $5,000.00 $1,82,662.50