Question

A company is considering the purchase of a new machine that will enable it to increase its expected sales. The machine will have a price of $100,000. In addition, the machine must be installed and tested. The costs of installation and testing will amount to $10,000. The machine will be depreciated using 3-years MACRS. (Use MACRS table from class excel exercise by copying the table and pasting it) The equipment will be operated for 5 years. The sales in the first year of operation are expected to be $260,000. Then, sales will grow by 3% a year. The annual operating costs (before depreciation) will consist of fixed operating costs of $25,000 plus variable operating costs equal to 70% of sales. To support the increased level of production, the inventory of raw materials will have to be increased from $30,000 to $50,000 when the machine is purchased. The additional inventory will be carried until the machine is scrapped following the 5 years of operation. At the end of the 5-year operating life of the project, it is assumed that the equipment will be sold for $40,000. The tax rate is 40% and the company’s weighted average cost of capital is 9%. Build a capital budgeting model to answer the following questions:

1) What is the operating cash flow in year 1-5?

2) What is the initial outlay in year 0?

3) What is the after tax salvage at the terminal year?

4) Calculate NPV and PI for the project. Check points: NI in year 2 = $3,834 IRR = 26.73%

Bonus: Using data table show the effect of changes in CGS on NPV for the project Start with CGS of 30% stepping by 5% and stopping at 70%.

Answer 1

1) Refer the Operating Cash Flow row in Table Below

2) Year 0 of Operating Cash Flow

3) The sales was at $40,000. Since the machine was completely depreciated, the $40000 is profit. SO the tax at 40% needs to be paid in the last on $40000.

4) Refer table below