Question

You are evaluating a proposal to buy a new milling machine. The base price is $108,000 and shipping and installation costs would add another $12,500. The machine would be sold after 3 years for $65,000. The machine would require a $5,500 increase in net working capital (inventory). There would be revenues of $44,000 per year and cost of $10,000 per year. The company's tax rate is 35%, and the cost of capital (WACC) is 12%. Also the firm spent $15,000 last year investigating the feasability of using the machine. The opportunity cost of purchasing the machine is $5,000.

A) How should the $15,000 spent last year be handled?

B) What are the cash flows for each year - Initial cash flow. Operating cash flow and terminal cash flow?

C) Should the machine be purchased?

Answer 1

A) How should the $15,000 spent last year be handled?

Since it was spent last year on investigation, it will be treated as a sunk cost

B) What are the cash flows for each year - Initial cash flow. Operating cash flow and terminal cash flow?

Increase in working capital 5500

base price 108000

installation cost 12500

Total machine cost 120500

Total initial cash outflow is 126000 The above table has the Operating cash flow and the present values discounted at 12%. Below table has the Terminal value calculation. The NPV is negative NPV -4771.46, the machine should not be purchased