NEW PROJECT ANALYSIS You must evaluate a proposal to buy a new milling machine. The base price is $193,000, and shipping and installation costs would add another $10,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $125,450. 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 $40,000 per year. The marginal tax rate is 35%, and the WACC is 10%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.
|
a: II
The amount spent is sunk cost since it is irrelevant to decision making.
b: Initial outlay =210500
c: Year 1 CF = 49446.5
Year 2 CF = 57972.5
Year 3 CF = 130673.5
d:No
(Since NPV is negative)
Workings
Year | Cost
of new machine |
Working capital | Tax
shield- depreciation |
Sale
of new machine |
Net
savings after tax |
Net CF |
0 | -203000 | -7500 | -210500.00 | |||
1 | 23446.5 | 26000 | 49446.50 | |||
2 | 31972.5 | 26000 | 57972.50 | |||
3 | 7500 | 10657.5 | 86516 | 26000 | 130673.50 | |
NPV | -19460.54 |
Sale of new Machine | |
Selling price | 125450 |
Less: Book value | 14210 |
Gain on sale | 111240 |
Tax on gain | 38934 |
Net Sale proceeds | 86516 |
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