Question

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 $4,000 after taxes. It would cost $4,000 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 9 percent interest from its local​ bank, resulting in additional interest payments of $9,000 per year. Assume simplified​ straight-line depreciation and that the machine is being depreciated down to​ zero, a 34 percent marginal tax​ rate, and a required rate of return of 14 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

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Part a: Initial Outlay
Purchase Cost of Machine		$150,000
Installation Cost		$    4,000
Increase in Working Capital		$ 15,000
Training Cost of Workiers		$    4,000
Initial Outlay		$173,000
Part b: Annual Cash flow
Earning before Interest and Tax		$ 60,000
Less: Interest		$    9,000
Less: Depreciation	154000/10	$ 15,400
Net Income		$ 35,600
Tax 34%		$ 12,104
Net Cash inflow:
Earning before Interest and Tax		$ 60,000
Less: Interest		$    9,000
Less: Tax		$ 12,104
Annual after tax Cash Flow		$ 38,896
Part c: Terminal Cash Flow
Annual after tax Cash Flow		$ 38,896
Add: Working capital release		$ 15,000
Termincal Cash flow		$ 53,896
Part d: Decision
Initial outlay			$-173,000
PV of Annual Cash flow @ 14% for 9 Years	38896*4.9464		$ 192,395
PV of Terminal Cash flow @ 14% 10th year	53896*0.2697		$    14,536
Net Present Value			$    33,931
Since NPV is positive, it is good to purchase