Question

• A toy company just spent $10,000 to do an analysis and determined that a new machine would help meet the increased demand for toys. So the company is considering investing in a new machine today. The cost of the machine is $100,000 and the machine is to be fully depreciated over 10 years using the straight-line depreciation method. The machine will be placed in a factory that is currently being rented out at $1.000 per year, and the current tenant will • The new machine will produce 1,000 toys, which will be priced at $11 each. The cost per toy is $1 each. • At the end of 2 years, you expect production will cease and you will be able to sell the machine for $80,000. . It is estimated that the firm needs to hold net working capital equal to 10% of total sales and that it will need to be injected today if the machine is purchased. The NWC balance will be withdrawn at the end of the project. The firm is in the 10% tax bracket and the opportunity cost of capital is 1096 The management team has prepared the cash flow table as in below. 1 2 (900) (900) (1) (3) (4) NOPAT Depreciation Change in NWC Cap Expenditure Salvare Value Tax on Gain FCF (2) (100,000) (5) (6) a) Fill in the missing information highlighted in the cell above • (2) - • (3) -

Answer 1

Solution:

1.Calculation of depreciation for first year

Depreciation=Cost of machine/life

=$100,000/10

=$10,000

2.Calculation of Change in net working capital(NWC)

2)NWC require today=Total sale*10%

=(1000*$11)*10%

=-$1100

3)There will be no change in the working capital as sale is same.Hence the answer is NIL

4)There is recovery of NWC in year 2,hence change in net working capital is;

=Balance-requirement

=$1100-0

=$1100.

5.Salvage value=$80,000

6.Calculation of tax on gain

Book value of machine at year end 2=Cost of machine-Depreciation for years

=$100,000-($10,000*2)

=$80,000

Since the book value of machine is equal to the salvage value of machine,hence there is no gain and thereby no tax on gain.Accordingly answer is NIL.

b)Since the NPV of machine is negative,hence I would not accept the project.Thus answer is NO.