Question

You must evaluate a proposal to buy a new milling machine. The base price is $186,000, and shipping and installation costs would add another $15,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $74,400. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $4,000 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 $52,000 per year. The marginal tax rate is 35%, and the WACC is 13%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine. How should the $5,000 spent last year be handled? The cost of research is an incremental cash flow and should be included in the analysis. Only the tax effect of the research expenses should be included in the analysis. Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay. Last year's expenditure is considered as an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. Last year's expenditure is considered as a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.

What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent.
$ ______ 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.
Year 1 $ _______
Year 2 $ _______
Year 3 $ _______

Should the machine be purchased?

Answer 1

Tax rate	35%
	Year-1	Year-2	Year-3
Saving in labor cost	52,000	52,000	52,000
Less: Depreciation as per table given below	66,330	90,450	30,150
Profit before tax	(14,330)	(38,450)	21,850
Tax	(5,016)	(13,458)	7,648
Profit After Tax	(9,315)	(24,993)	14,203
Add Depreciation	66,330	90,450	30,150
Cash Profit After tax	57,016	65,458	44,353
Cost of macine		201,000
Depreciation		186,930
WDV		14,070
Sale price		74,400
Profit/(Loss)		60,330
Tax		21,116
Sale price after tax		53,285
Depreciation	Year-1	Year-2	Year-3			Total
Cost	201,000	201,000	201,000
Dep Rate	33.00%	45.00%	15.00%
Deprecaition	66,330	90,450	30,150			186,930
Calculation of NPV
Year	Captial	Working captial	Operating cash	Annual Cash flow	PV factor @ 13%	Present values
0	(201,000)	(4,000)		(205,000)	1.000	(205,000)
1			57,016	57,016	0.885	50,456
2			65,458	65,458	0.783	51,263
3	53,285	4,000	44,353	101,637	0.693	70,440
				Net Present Value		(32,841)
Since NPV is negative, it should not be accepted