Question

A company is evaluating the proposed acquisition of a new machine. The machine’s base price is $108,000, and it would cost another $12,500 to modify it for special use. Depreciation rates are 0.33, 0.45, and 0.15 for years 1, 2, and 3, respectively, and it would be sold after 3 years for $65,000. The machine would require an increase in net working capital (inventory) of $5,500. The machine would have no effect on revenues, but it is expected to save the firm $44,000 per year in before-tax operating costs, mainly labor. The company’s marginal tax rate is 35%.

a. What is the net cost of the machine for capital budgeting purposes? (That is, what is the Year-0 net cash flow?)

b. What are the net operating cash flows in Years 1, 2, and 3?

c. What is the additional Year-3 cash flow (i.e., the after-tax salvage and the return of

working capital)?
d. If the project’s cost of capital is 12%, should the machine be purchased?

Answer 1

		Answer 1
			Net cash flow at time 0=Net working cpital Investment +fixed capital Investment
			Net cash outflow=108000+12500+5500
			Net cash outflow=	126,000
		Answer 2		Year	Dep rate	Dep expense
	Net asset value=	120,500		1	33%	39,765
				2	45%	54,225
				3	15%	18,075
				Total		112,065
				Book value at year 3	120500-112065
				Book value at year 3	8,435
					1	2	3
				Before tax operating cost	44,000	44,000	44,000
				Less tax	(15,400)	(15,400)	(15,400)
				After tax operating cost	28,600	28,600	28,600
				add depreciation	39,765	54,225	18,075
				Cash flow	68,365	82,825	46,675
		Answer 3
			additional year 3 cash flow=salvage vale+net working capital-tax(salvage value-book value)
			Year 3 additional cash flow=	5500+65000-0.35*(65000-8435)
			Year 3 additional cash flow=	50,702
		Answer 4	Project is acceptable because of positive NPV
					Method 1
					calculate NPV Using NPV Function in excel and subtract Initial cash Outflow from it
					Year	Machine A
					0	(126,000)
					1	68,365
					2	82,825
					3	97,377
					Discount rate	12%
					NPV=	70,378.96
				Method 2
				Using Financial Calculator
					Press CF
					CF0=	(126,000)	(Press Enter and scroll down)
					CF1=	68,365	(Press Enter and scroll down Twice)
					CF2=	82,825	(Press Enter and scroll down Twice)
					CF3=	97,377	(Press Enter and scroll down Twice)
					Press NPV
					Interest=	12%	(Press Enter and scroll down)
					Press CPT+NPV
					NPV=	70,378.96