Question

Read Book Company is the manufacturer of exercise machines and is considering producing a new line of equipment in an effort to increase its market share.    The new production line will cost $850,000 for manufacturing the parts and an additional $280,000 is needed for installation. The equipment falls into the MACRS 3‐yr class, and would be sold after four years for $350,000. The equipment line will generate additional annual revenues of $600,000, and will have additional annual operating expenses of $300,000. An inventory investment of $75,000 is required during the life of the project. Read Book Company is in the 25 percent tax bracket, and its existing cost of capital is 8 percent. a. Calculate the initial outlay of the project b. Calculate the annual after‐tax operating cash flow for Years 1 ‐4.   c. Determine the terminal year non‐operating cash flow in year 4:   d. What is the equipment NPV?    e. What is the estimated Internal Rate of Return (IRR) of the equipment?    f. Should the equipment be accepted based on the IRR criterion?    

Answer 1

Woodland Corporation purchased a printing machine three (3) years ago and is considering replacing it with a new one which is faster and easier to operate.  The old machine has been depreciated over 3 years using straight line depreciation.    Its original installation cost was $15,000.  The old machine has been in use for 2 years, and it can be traded in for $3,500.    The new machine will be purchased $24,000 and it will also be depreciated over 3 years using the straight line method.  It is not expected to have a residual value.  Net working capital will decrease because supply levels can be reduced by $1,500.   Revenues will increase by $5,000 every year, it will result in laborsavings of $3,000 per year due to its greater speed.  Reducing training expenses are expected to save an additional $2,500 per year.  The firm is in the 20% tax bracket. Required: i. Calculate the operating cash flows from years 1 to 3.       ii. What is the terminal year non‐operating cash flow?