Problem 12-9 New project analysis You must evaluate a proposal to buy a new mill
ID: 2789685 • Letter: P
Question
Problem 12-9 New project analysis You must evaluate a proposal to buy a new milling machine. The base price is $173,000, and shipping and installation costs would add another $15,000. The machine falls into the MACRS 3 year class, and it would be sold after 3 years for $86,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $7,500 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 $49,000 per year. The marginal tax rate is 35%, and the WACC is 14%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine. 9 a. How should the $5,000 spent last year be handled? I. Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay. II. Last year's expenditure is considered an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis III. Last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. IV. The cost of research is an incremental cash flow and should be included in the analysis V. Only the tax effect of the research expenses should be included in the analysis. -Select- b. What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent. c. What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent. Year 1$ Year 2 $ Year 3 $ d. Should the machine be purchased? -Select-Explanation / Answer
Answer A: option 3 is the answer. it is a sunk cost you opt for the project or not it wont effect the outcome either way. thats why no use of taking it in to the analysis
Answer B. Initial investment outlay
Machine investment cost = $173,000
Installation cost = $15000
net working capital increase : $7500
Total intial outlay = $195500
Answer C: projected annual Cash flow
Present value formula = cash flow/(1 + interest rate ) ^ ( no of years)
Depreciation : percent given in the question taken for calculation on total machine value
Answer D : As you can see the NPV ( sum of all present values) is coming negative
NPV = -$92508.6
machine should not be purchased
0 1 2 3 Machine investment 173000 Installation cost 15000 Salvage value 86500 Depreciation 62040 84600 28200 Net working capital 7500 Labor cost save 49000 49000 49000 Cash flow -195500 -13040 -35600 107300 Tax (35%) 0 0 0 37555 Net cash flow (adding back depreciation-tax) -195500 49000 49000 97945 present value of cash flow -195500 36296.3 26886.15 39808.97