Question

Click here to read the book: Analysis of an Expansion Project NEW PROJECT ANALYSIS You must evaluate a proposal to buy a new ing machine. The base price is $170,000, and shipping and installation costs would add another $20,000. The machines into the MACRS 3-year class, and it would be sold after 3 years for $76,500. The applicable depreciation rates are 334,45, 15and 74. 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 preta labor costs would decine by $54,000 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 a. How should the $5,000 spent last year be handled? 1. The cost of research is an incremental cash flow and should be included in the analysis II. Only the tax effect of the research expenses should be included in the analysis III. Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's it. Hence, it should not be included in the initial investment outlay. IV. Last year's expenditure is considered as an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. V. Last year's expenditure is considered as a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. b. What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year project cash flow? Round your answer to the nearest cent. What are the project's annual cash flows during Years 1, 2, and 37 Round your answer to the nearest cent. Do not round your intermediate calculations Year 15 Year 25 Year 3$ d. Should the machine be purchased? -Select-

Answer 1

Solution: a.How should the $5,000 spent last year be handled? V.Last year's expenditure is considered as a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. b) Year O net cash flow cost of machine Installation cost increase in net working capital Year Onet cash flow -170000.00 -20000.00 -3000.00 -193000.00 1 2 3 35100.00 35100.00 35100.00 c) annual cash flow after tax savings =54000*(1-0.35) tax shiled on depreciation = (170000+20000)*Depreciation rate * tax rate after tax sale value** recapture of working capital annual cash flow 21945.00 29925.00 9975.00 54380.00 3000.00 57045.00 65025.00 102455.00 3 d) Calculation of NPV Initial Investment annual cash flow net cash flow discount factor at 14% 0 1 -193000.00 57045.00 65025.00 102455.00 -193000.00 57045.00 65025.00 102455.00 1.00000 0.87719 0.76947 0.67497 -193000.00 50039.47 50034.63| 69154.21 -23771.69 PV NPV NO, machine should not be purchased as it has negative NPV. 190,000 176,700 after tax sale value * cost=170000+20000 LESS : accumulated depreciation = 190000*(0.33+0.45+0.15) book value sale value Gain on sale Tax on gain=63200*0.35 after tax sale value 13,300 76,500 63,200 22,120 54,380