Question

(Calculating project cash flows and NPV)?? Weir's Trucking, Inc. is considering the purchase of a new production machine for $115,000. The purchase of this new machine will result in an increase in earnings before interest and taxes of $27,000 per year. To operate this machine properly, workers would have to go through a brief training session that would cost $5500 after tax. In addition, it would cost 5500 after tax to install this machine correctly. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory of $27,000. 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 $90,000 at 10 percent interest from its local bank, resulting in additional interest payments of $9,000 per year. Assume simplified straight-line depreciation, that this machine is being depreciated down to zero, a 32 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 (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

A. Initial Outlay of the project is $153,000.

B. Annual after-tax cash flows from year 1 - 9 = $24,790

C. Since the salvage value is zero (and no tax benefit/loss arising from it), there is no net return of working capital etc., the annual cash flow in year is equal to the annual cash flows occuring from year 1 - 9.

D. The NPV is -$28,584.7 ( a loss from the project). Thus, the project should not be taken up.