Question

You must evaluate a proposal to buy a new milling machine. The base price is $104,000, and shipping and installation costs would add another $18,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $57,200. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $7,000 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $36,000 per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.

What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent. Do not round your intermediate calculations.

Answer 1

The $5,000 the firm spent on feasibility study will not be considered since we do not take into consideration research costs in NPV since they are sunk costs

Now, we calculate the after tax slavage value

Sale price = 57,200

Book value at end of year 3 = 0.07*(104,000)=7280

Taxable value =57,200-7280 =49920

Taxes = 35%*49920 = 17,472

After tax salvage value = 57,200-17,472 = $39,728

The cash flows for the 3 years are as shown below:

Year	1	2	3
Savings	$   36,000.00	$   36,000.00	$   36,000.00
Depreciation	$ -40,260.00	$ -54,900.00	$ -18,300.00
Savings before tax	$   -4,260.00	$ -18,900.00	$   17,700.00
Taxes at 35%	$     1,491.00	$     6,615.00	$   -6,195.00
Profit after tax	$   -2,769.00	$ -12,285.00	$   11,505.00
Add back depreciation	$   40,260.00	$   54,900.00	$   18,300.00
After tax salvage value			$   39,728.00
Return of working Cap.			$     7,000.00
Net cash flow	$   37,491.00	$   42,615.00	$   76,533.00