Question

(New project analysis) Garcia's Truckin' Inc. is considering the purchase of a new production machine for $150,000. The purchase of this machine will result in an increase in earnings before interest and taxes of $60,000 per year. To operate the machine properly, workers would have to go through a brief training session that would cost $7,000 after taxes. It would cost $6,000 to install the machine properly. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory of $15,000. This machine has an expected life of 10 years, after which it will have no salvage value. Finally, to purchase the new machine, it appears that the firm would have to borrow $100,000 at 11 percent interest from its local bank, resulting in additional interest payments of $11,000 per year. Assume simplified straight-line depreciation and that the machine is being depreciated down to zero, a 31 percent marginal tax rate, and a required rate of return of 13 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 (what is the annual after-tax cash flow in year 10 plus any additional cash flows associated with the termination of the project)? d. Should the machine be purchased?

Answer 1

Answer: a) Initial Outlay Associated with the project = $ 150,000+$ 7000+$6000=$ 163,000 b) Caculation of After Tax Cash Flows Depreciation expenses = $ 163000 /10 Depreciation expenses = $ 16300 Particulars Amount Incremental Earnings $ 60,000 Less: Incremabtal Inventory $ 15,000 Less: intersest Expenses $ 11,000 Less: Depreciation $ 16,300 Net income Before Tax $ 17,700 Less: Tax @31% $ 5,487 Net income After tax $ 12, 213 Add: Depreciation $ 16,300 Cash Flow $ 28,513 c) No Addittional termonal Cash Flows Associated with Projects Thefore the Last year Cash Flows = $ 28513 d) NPV Paeriod Cash Flows PVF @ 13% Present Value 0 -163000 1 - 163000 1-10 28513 5.4262 154717.2406) NPV -8282.7594 NPV is Negative Should not buy Machine