Question

You must evaluate a proposal to buy a new milling machine. The purchase price of the milling machine, including shipping and installation costs, is $134,000, and the equipment will be fully depreciated at the time of purchase. The machine would be sold after 3 years for $91,000. The machine would require a $5,000 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 $59,000 per year. The marginal tax rate is 25%, and the WACC is 12%. Also, the firm spent $4,500 last year investigating the feasibility of using the machine.

A.What is the initial investment outlay for the machine for capital budgeting purposes after the 100% bonus depreciation is considered, that is, what is the Year 0 project cash flow? Enter your answer as a positive value. Round your answer to the nearest dollar.

B.What are the project's annual cash flows during Years 1, 2, and 3? Do not round intermediate calculations. Round your answers to the nearest dollar.
Year 1: $   
Year 2: $   
Year 3: $  

Answer 1

Question A:

Year 0 net cash flow is $105,500

Question B:

Project's Annual Cash Flows

Year 1 : $44,250

Year 2 : $44,250

Year 3 : $117,500

Calculation of Project's Cash Flows and NPV
Particulars	Year 0	Year 1	Year 2	Year 3
Initial Investment
Capital Investment	-134,000
Investment in net Working Capital	-5,000
Net Investment (A)	-139,000
Operating Cash Flows
Saving in Pre tax labor costs (B)		59,000	59,000	59,000
Depreciation (C) $134,000 * 100%	134,000	-	-	-
Profit before tax (D = B-C)	-134,000	59,000	59,000	59,000
Tax @25% (E = D*25%)	-33,500	14,750	14,750	14,750
Profit After tax (F = D-E)	-100,500	44,250	44,250	44,250
Depreciation (G = C)	134,000	-	-	-
Net Operating Cash Flows (H = F+G)	33,500	44,250	44,250	44,250
Terminal Value
Sale Value (I)				91,000
Tax @25% (J = I*25%)				22,750
Net Sale Value (K = I-J)				68,250
Recovery of Working Capital (L)				5,000
Net Terminal value (M = K+L)				73,250
Total Cash Flow (N = A+H+M)	-105,500	44,250	44,250	117,500
Discount Factor@12% (O) 1/(1+12%)^n n=0,1,2,3	1	0.8928571	0.79719388	0.71178025
Discounted Cash Flows (P = N*O)	-105500	39508.929	35275.8291	83634.1791
NPV of the Project	52918.9368