New project analysis PLEASE ROUND CORRECTLY AND FOLLOW WHAT THE PROBLEMS SAYS TH
ID: 2762663 • Letter: N
Question
New project analysis PLEASE ROUND CORRECTLY AND FOLLOW WHAT THE PROBLEMS SAYS THANKS
You must evaluate a proposal to buy a new milling machine. The base price is $135,000, and shipping and installation costs would add another $11,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $60,750. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $7,000 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 $38,000 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.
1.How should the $5,000 spent last year be handled? PLEASE SELECT ONE BELOW
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.
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.
The cost of research is an incremental cash flow and should be included in the analysis.
Only the tax effect of the research expenses should be included in the analysis.
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.
2. 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.
$
3. 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 $
4.Should the machine be purchased? yes or no?
Explanation / Answer
1. the $5,000 spent last year be handled :-
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.
2. Initial Investment
$ Cost of equipment 135,000 Installation cost 11,000 Spares Cost 7,000 Initial outflow 153,000 Year 1 Year 2 Year 3 Total Depreciation Rate 33% 45% 15% Amount of Depreciation 50,490 68,850 22,950 142,290 Tax Saving on Depreciation @ 35% 17,672 24,098 8,033 WDV after 3 years = $ 153000- $ 142290 = $ 10710 Sale value of Machinery after 3 years = $ 60750 Gain on sale of Machinery = $ 60750- $ 10710 = 50040. Tax on Gain of Machinery = $ 50040 X 35% = 17514 3. Cash flow from the equipment Year 1 Year 2 Year 3 Total Saving in Labour cost $ 38,000 38,000 38,000 Additional Tax on saving on labour a@ 35% $ (13,300) (13,300) (13,300) Tax Saving on Depreciation $ 17,672 24,098 8,033 Sale of Machinery 60,750 Tax on Gain of Machinery $ (17,514) Net Cash Flow $ 42,372 48,798 75,969 Discount Rate Factor @ 12% 0.893 0.797 0.712 Discounted Cash Flow $ 37,832 38,901 54,073 130,806 4) Machine should not be purchased as the Discounted purchase value after 3 years is $ 130806, which is less than the Initial Outflow of $ 153000.