New project analysis You must evaluate a proposal to buy a new milling machine.
ID: 2754179 • Letter: N
Question
New project analysis
You must evaluate a proposal to buy a new milling machine. The base price is $117,000, 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 $46,800. 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 $52,000 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.
Year 1 $
Year 2 $
Year 3 $
Should the machine be purchased?
Explanation / Answer
Initial cash outflow = $117000 + 13000 + 5500
= $135500
Calculation of Annual cash flows
Evaluation of purchase proposal
Calculation of NPV
NPV = $47314x0.893 + 52228x0.797 + 92243x0.712 - 135500
= $14054
Since NPV is positive, this machine should be purchased
Working Notes:
Calculation of tax savings on depreciation
1 2 3 Savings in labour cost $52000 $52000 $52000 Less: Tax @ 18200 18200 18200 Add: tax savings on depreciatio 13514 18428 6143 Add: salvage value of machine 0 0 46800 Add: Release of working capital 0 0 5500 Cash flows 47314 52228 92243