Question

XYZ is now evaluating the purchase of a new machine for $210,000 installed with no NWC change. They plan to sell the machine at the end of 3 years for $30,000. MACRS 3 year depreciation. With the more efficient machine, labor savings per year are expected to be $70,000, $94,000 and $76,000 respectively. 40% tax. The cost of capital for this project is 8.%

The option of working cooperatively with another company has just been presented instead of purchasing the new machine. The details of this option are: initial investment of $120,000, net operating cash flows (years 1-3) of 47,000, 49,000 and 52,000 respectively (already takes into account depreciation effect and terminal cash flow so there is no need to calculate depreciation effect or terminal value just use these as-is for your analysis), cost of capital for this project is 8.2%.

1. Besides analyzing the numbers, list two areas of concern XYZ might look at when deciding whether to choose working cooperatively with another company. State in 25 words or less.

Answer 1

Year	cost of new machine	MACRS rate	annual depreciation
1	210000	33.33%	69993
2	210000	44.45%	93345
3	210000	14.81%	31101
accumulated depreciation			194439
Book value at the end of year 3	210000-194439	15561
Gain on sale of machine	30000-15561	14439
tax on gain on sale	14439*40%	5775.6
after tax sale proceeds	30000-5775.6	24224.4
Year	0	1	2	3
Initial cash outflow	-210000
incremental cash flow		70000	94000	76000
less depreciation		69993	93345	31101
operating income		7	655	44899
after tax income = operating income*(1-tax rate)		4.2	393	26939.4
add depreciation		69993	93345	31101
after tax sale proceeds				24224.4
net operating cash flow	-210000	69997.2	93738	82264.8
present value factor at 8% =1/(1+r)^n r =8%	1	0.925925926	0.85733882	0.7938322
present value 0f cash flow at 8% =net operating cash flow*present value factor	-210000	64812.22222	80365.22634	65304.451
Net present value = sum of present value of cash flow	481.90
Year	0	1	2	3
net operating cash flow	-120000	47000	49000	52000
present value factor at 8.2% =1/(1+r)^n r =8.2%	1	0.924214418	0.85417229	0.7894383
present value of cash flow at 8.2% =net operating cash flow*present value factor	-120000	43438.07763	41854.44221	41050.794
Net present value = sum of present value of cash flow	6343.31
Between the selection of working with new machinery and set up or with cooperatively with another company, it is better to work cooperatively with another company as its NPV is greater than the option of working with new machinery
Few concerns with working cooperatively with other company are (1) control is one of the concern which can create problems form working cooperatively with another company (2) share of resources and knowledge