New project analysis You must evaluate a proposal to buy a new milling machine.
ID: 2752758 • Letter: N
Question
New project analysis
You must evaluate a proposal to buy a new milling machine. The base price is $144,000, and shipping and installation costs would add another $7,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $93,600. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $5,000 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 $45,000 per year. The marginal tax rate is 35%, and the WACC is 12%. 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
The firm spent $5,000 last year investigating the feasibility of using the machine.- is a SUNK cost and will not form part of Initial Investment.
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The initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow = Base Price of the new milling machine + shipping and installation costs + increase in net operating working capital
= 144,000 + 7,000 + 5,000
= $156,000
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Depreciation for year-1 = 151,000*33%
= $49,830
Depreciation for year-2 = 151,000*45%
= $67,950
Depreciation for year-3 = 151,000*15%
= $22,650
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Book value of the Equipment at the end of third year = 151,000*7%
= $10,570
Sale value the Equipment = 93,600
Profit on sale of Equipment = 93,600 - 10,570
= $83,030
Tax on Profit = 83,030*35%
= $29,060
Net Sales Proceeds from Sale value of Equipment = 93,600 - 29,060
= $64,540
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Projects Cash Inflow in Year-1 = After Tax savings in Labor Cost + Depreciation Tax Sheild
= (45,000*0.65) + (49,830*0.35)
= $46,690.50
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Projects Cash Inflow in Year-2 = After Tax savings in Labor Cost + Depreciation Tax Sheild
= (45,000*0.65) + (67,950*0.35)
= $53,032.50
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Projects Cash Inflow in Year-3 = After Tax savings in Labor Cost + Depreciation Tax Sheild + Recovery of Working Capital + Net Sale proceeds from Sale of Equipment
= (45,000*0.65) + (22,650*0.35) + 5,000 + 64,540
= $10,6717.50