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 ​$40,000 per year. To operate the machine​ properly, workers would have to go through a brief training session that would cost ​$7,000 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 12 percent interest from its local​ bank, resulting in additional interest payments of ​$12,000 per year. Assume simplified​ straight-line depreciation and that the machine is being depreciated down to​ zero, a 35 percent marginal tax​ rate, and a required rate of return of 15 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

annual after tax cash flow = earnings after tax + depreciation

annual depreciation = total cost of machine / expected life of machine

total cost of machine = purchase cost + installation cost + training cost

total cost of machine = $150,000 + $4,000 + $7,000 = $161,000.

annual depreciation = $161,000 / 10 = $16,100.

Terminal year cash flow = annual after tax cash flow + recovery of working capital

NPV is calculated using NPV function.

NPV is -$21,227

The machine should not be purchase because the NPV is negative.