Question

​(Calculating project cash flows and​ NPV)  The Chung Chemical Corporation is considering the purchase of a chemical analysis machine. Although the machine being considered will result in an increase in earnings before interest and taxes of $ 33 comma 000 per​ year, it has a purchase price of ​$110 comma 000​, and it would cost an additional ​$4 comma 000 after tax to correctly install this machine. In​ addition, to properly operate this​ machine, inventory must be increased by ​$5 comma 500. This machine has an expected life of 10 ​years, after which it will have no salvage value. ​ Also, assume simplified​ straight-line depreciation, that this machine is being depreciated down to​ zero, a 35 percent marginal tax​ rate, and a required rate of return of 11 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 ​(that is, the annual​ after-tax cash flow in year 10 plus any additional cash flows associated with termination of the​ project)?

d.  Should this machine be​ purchased?

Answer 1

R19 A 1 Solution :- H I J K L M C D E F G Cost of Machine = $110000+ $4000 = $114000 Dep per year = $114000 / 10 = $11400 Working Capital Investment = $5500 mo 1 2 3 4 5 6 7 8 9 10 0 -114000 -5500 33000 11400 21600 6 Year 7 Initial Cost 8 WC investment 9 Incremental EBIT 10 Less :- Dep 11 Net EBIT 12 Less :- Tax @ 35% 13 Earning After tax 14 Add :- Dep 15 Cash flow after tax 16 Working Capital Recovered 17 18 Net Cash Flow 19 PVF@11% 20 Present Value of Cashflow 33000 33000 33000 33000 33000 33000 33000 11400 11400 11400 11400 11400 11400 11400 21600 21600 21600 21600 21600 21600 21600 7560 14040140401404014040140401404014040 11400 11400 11400 11400 11400 11400 11400 25440 25440 25440 25440 25440 25440 25440 33000 33000 11400 11400 21600 21600| 7560 7560 1404014040 11400 11400 25440 25440 5500 14040 11400 25440 | -119500 25440 25440 25440 25440 1.000 0.901 0.812 0.731 0.659 -119500 22918.92 20647.67 18601.51 16758.12 25440 25440 25440 2 5440 25440 0.593 0.535 0.482 0.434 0.391 15097.4 13601.26 12253.39 11039.09 9945.126 30940 0.352 10896.59 22 NPV = Sum of Present Value of Cashflows 32259.08 23

(A) Initial Outlay = $114000 + $5500 = - $119500

(B) Annual After tax cashflow Year 1 - 9 = $25440

(C) Terminal Cashflow in Year 10 = $30940

(D) The Machine should be purchase as its NPV is greater than equal to 0 .

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