Question

The Guo Chemical Corporation is considering the purchase of a chemical analysis machine. The purchase of this machine will result in an increase in earnings before interest and taxes of ​$65,000 per year. The machine has a purchase price of ​$350,000​,and it would cost an additional $9,000 after tax to install this machine correctly. In​ addition, to operate this machine​ properly, inventory must be increased by ​$14,000. This machine has an expected life of 10 years, after which time it will have no salvage value. ​ Also, assume simplified​ straight-line depreciation, that this machine is being depreciated down to​ zero, a 38 percent marginal tax​ rate, and a required rate of return of 9 percent.

a.  What is the initial outlay associated with this​ project?

b.  What are the annual​ after-tax cash flows associated with this project for years 1 through 9​?

c.  What is the terminal cash flow in year 10​(that is, the annual​ after-tax cash flow in year 10 plus any additional cash flow associated with termination of the​ project)?

d.  Should this machine be​ purchased?

Answer 1

a.the initial outlay associated with this project = $373,000
=
b. the annual​ after-tax cash flows associated with this project for years 1 through 9​ = $53,600

c. the terminal cash flow in year 10​(that is, the annual​ after-tax cash flow in year 10 plus any additional cash flow associated with the termination of the​ project) = $67,600

d. NPV = net present value= present value of cash inflow- present value of cash outflow.
Discounted at the required rate of return (9%)

NPV = -23,100.80
This machine should not be purchased because the npv is negative.

a Inital outlay (puechase tinstallation) + Invetory - (350,000 + 9000), 359000 >) 359,000 + 14,000 = 373000 CF, to CF q = - After tax earnings & tax sheild due to depreciation 65,000 (1-0-88) + ( 350000 - O x 0.38) 10 = $53,600 - 0 c. terminal cash flow = + inventory release = 53,600+ 14000 CFio = 64,600 CFn do 373000 de NPU- E CFO - 343000 MPV= DI (1009)" = $ 23,100.80