Carlson Corp. is considering whether to expand widget production. This would require the purchase of a...

Carlson Corp. is considering whether to expand widget production. This would require the purchase of a new widget-producing machine at a cost of $5,400,000. The machine would produce 450,000 widgets per year during its useful life of three years, and would be depreciated for tax purposes at a rate of $1,800,000 per year. The machine would have a salvage value of $500,000. Expanding widget production would also require the use of a building that could otherwise be leased for $500,000 per year. Working capital would be 12% of the next year’s sales. Widget prices are $20 and are expected to remain stable. The materials and labor required to produce a widget cost $12, and these costs are also expected to remain stable. The income tax rate is 21%. The discount rate is 10% per year.

(a) Compute the incremental free cash flow resulting from the purchase of a widget machine on a year-by-year basis.

(b) What is the NPV of the widget machine?

Expert Solution

(a) Calculation of incremental cash flows

Particulars	Year 0	Year 1	Year 2	Year 3
No. of widgets		450,000	450,000	450,000
Sale price per widget		20	20	20
Variable cost per widget		12	12	12
Sales		9,000,000	9,000,000	9,000,000
Variable costs		(5,400,000)	(5,400,000)	(5,400,000)
Opportunity cost of building		(500,000)	(500,000)	(500,000)
Depreciation		(1,800,000)	(1,800,000)	(1,800,000)
Cash flows before tax		1,300,000	1,300,000	1,300,000
Taxes @ 21%		(273,000)	(273,000)	(273,000)
Cash flows after tax		1,027,000	1,027,000	1,027,000
Add: Depreciation		1,800,000	1,800,000	1,800,000
Gross cash flows		2,827,000	2,827,000	2,827,000
Capital investment	(5,400,000)	-	-	-
Net working capital [9,000,000*12%]	(1,080,000)	-	-	1,080,000
Salvage value after tax [500,000(1-0.21)]				395,000
Incremental cash flows	(6,480,000)	2,827,000	2,827,000	4,302,000

(b) Computation of NPV of widget machine

Particulars	Year 0	Year 1	Year 2	Year 3
Incremental cash flows	(6,480,000)	2,827,000	2,827,000	4,302,000
PVF @ 10%	1.0000	0.9091	0.8264	0.7513
Present value	(6,480,000)	2,570,000	2,336,364	3,232,156
Net present value [Sum of PV]	1,658,520

jeff jeffy answered 3 years ago

MBA Corp is considering whether to expand widget production. This would require the purchase of a...

MBA Corp is considering whether to expand widget production. This would require the purchase of a new widget-producing machine at a cost of $5,400,000. The machine would produce 450,000 widgets per year during its useful life of three years, and would be depreciated for tax purposes at a rate of $1,800,000 per year. The machine would not have any salvage value. Expanding widget production would also require the use of a building that could otherwise be leased for $500,000 per...

2. Smith Corp. is considering whether to expand widget production. This would require the purchase of...

2. Smith Corp. is considering whether to expand widget production. This would require the purchase of a new widget-producing machine at a cost of $5,400,000. The machine would produce 450,000 widgets per year during its useful life of three years, and would be depreciated for tax purposes at a rate of $1,800,000 per year. The machine would have a salvage value of $500,000. Expanding widget production would also require the use of a building that could otherwise be leased for...

Delta Widget Corp. (DWC) is considering whether to purchase a new widget-producing machine at a cost...

Delta Widget Corp. (DWC) is considering whether to purchase a new widget-producing machine at a cost of $900,000. The machine would produce 100,000 widgets per year during its useful life of three years, and would be depreciated for tax purposes at a rate of $300,000 per year. No salvage value is expected. Currently, widget prices are $15. The materials and labor required to produce a widget cost $9. The inflation rate is expected to be 3% per year, and the...

The Lathe You are considering the purchase of a new lathe to expand production of a...

The Lathe You are considering the purchase of a new lathe to expand production of a hot product line. The lathe costs $280. It will have a life of four years. You will depreciate the lathe to zero book value using straight-line depreciation over four years. At the end of four years, you will sell the machine for $50. The new lathe will generate cash sales of $230 per year, and operating costs will run $120 per year. The firm...

A company is considering a 5-year project to expand production with the purchase of a new...

A company is considering a 5-year project to expand production with the purchase of a new automated machine using the latest technology. The new machine would cost $200,000 FOB St. Louis, with a shipping cost of $8,000 to the plant location. Installation expenses of $15,000 would also be required. This new machine would be classified as 7-year property for MACRS depreciation purposes. The project engineers anticipate that this equipment could be sold for salvage for $44,000 at the end of...

The director for S Corp. manufacturers of playground equipment, is considering a plan to expand production...

The director for S Corp. manufacturers of playground equipment, is considering a plan to expand production facilities in order to meet an increase in demand. He estimates that this expansion will produce a rate of return of 11%. The firm’s target capital structure calls for a debt/equity ratio of .8 . S Corp has a bond issue outstanding for that will mature in 25 years and has a 7% annual coupon rate. The bonds are currently selling for $804. The...

XYZ Steel Corporation is deciding whether to expand operations. The expansion would require purchasing a new...

XYZ Steel Corporation is deciding whether to expand operations. The expansion would require purchasing a new machine for $500,000, with additional $30,000 shipping and installation fees. The machine will be depreciated using a 7-year recovery period (use the percentages given in table 7-3 in the textbook). This project is expected to last 6 years, and the machine is expected to be sold for $200,000 at the end of year 6. In each of the six years of the project (years...

You are considering the purchase of a home that would require a mortgage of $250,000 (i.e....

You are considering the purchase of a home that would require a mortgage of $250,000 (i.e. you are borrowing $250,000 from a bank to buy the house. You intend to pay the bank back through equal monthly instalments). Suppose you are interested in the arithmetic sum of all the instalments you pay. How much more in total will you pay if you select a 30-year mortgage with an APR of 5.65% rather than a 15-year mortgage at an APR 4.9%?...

Surpasser Corp. is considering a new product that would require an investment of $9 million at...

Surpasser Corp. is considering a new product that would require an investment of $9 million at t = 0. If the new product is well received, then the project would produce after-tax cash flows of $3.75 million at the end of each of the next 3 years (t = 1, 2, 3), but if the market did not like the product, then the cash flows would be only $1.85 million per year. There is a 60% probability that the market will be...

Wansley Lumber is considering the purchase of a paper company. Purchasing the company would require an...

Wansley Lumber is considering the purchase of a paper company. Purchasing the company would require an initial investment of $300 million. Wansley estimates that the paper company would provide net cash flows of $40 million at the end of each year for the next 20 years. The cost of capital for the paper company is 13%. a. Should Wansley purchase the paper company? b. Wansley realizes that the cash flows in Years 1 to 20 might be $30 million per...

Question