Question

1.) Talbot Industries is considering launching a new product. The new manufacturing equipment will cost $17 million, and production and sales will require an initial $2 million investment in net operating working capital. The company's tax rate is 25%. Enter your answers as a positive values. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answers to two decimal places.

What is the initial investment outlay? $ million

The company spent and expensed $150,000 on research related to the new project last year. What is the initial investment outlay? $ million

Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for $1.1 million after taxes and real estate commissions. What is the initial investment outlay? $   million

2. Although the Chen Company's milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $108,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $19,500 per year. It would have zero salvage value at the end of its life. The project cost of capital is 10%, and its marginal tax rate is 25%. Should Chen buy the new machine? Do not round intermediate calculations. Round your answer to the nearest cent. Negative value, if any, should be indicated by a minus sign.

NPV: $  

Chen -Select-should or shouldn't purchase the new machine.

Answer 1

Answer 1 (a):

Initial investment outlay = cost of new manufacturing equipment + investment in net operating working capital

= $17 + $2

= $19 million

Initial investment outlay = $19 million

Answer 1 (b):

The $150,000 amount spent and expensed on research related to the new project last year, is a sunk cost and is not relevant for the project evaluation now. So, this amount is not added to initial investment.

Initial investment outlay = $19 million

Answer 1 (c):

The building could be sold for = $1.10 million after tax.

This being opportunity cost, has to be added to initial investment.

Initial investment = 19 + 1.10 = $20.10 million

Initial investment = $20.10 million

Answer 2:

Year 0:

Initial investment = $108,000

Information on current sale value of old machine and depreciation is not given and hence the same is not considered.

Year 1 to Year 10:

After-tax cash flows (labor savings and depreciation tax savings) = $19,500 per year

NPV = Annual after-tax cash flows * PV of $1 annuity for 10 years at 10% - Initial investment

= 19500 * (1 - 1 /(1 + 10%)^10)/10% - 108000

= $11,819.06

NPV = $11,819.06

Yes,

Chen should purchase the new machine.

It has positive NPV.