Question

TDK corp. capital budgeting

Existing:

salary and benefits for one full time operator- $35,000

cost of maintenance- 3,000 per year

cost of defects- 7,000 per year

original cost of old machine - 125,000

annual depreciation- 13,000 per year

current salvage value- 75,000

current age of machine- 4 years

Proposed:

cost of new machine- 160,000

instalation and shipping fees- 24,000

cost of maintenance- 4,000 per year

cost of defects- 3,000 per year

expected life- 6 years

salvage value at end of machines life- 33,000

depreciation method is straight line

also, the new machine will require TDK to increase their inventory level by $90,000 and also increase their current liabilities by $60,000. Prior to purchasing a new machine, TDK Paid a marketing consultant $8500 to determine the potential for new market share associated with replacing the old machine with a new machine with greater production capabilities. It should also be noted that a local merchant paid $7000 per year to use TDK’s Old machine during after hours for the production of their product. The merchant indicates that the new machine will not be suitable for her production process and therefore will discontinue the lease payment. Assuming TDK is in the 21% marginal tax bracket, calculate the initial investment and yearly cash flow’s associated with the new machine. Label all of your cash flow estimates

Answer 1

Existing
Salary-One Time	35,000
Annual Maintenance Cost	3,000
Annual Defect Costs	7,000
Original machine Cost	1,25,000
Annual Depreciation	13,000
Current Salvage Value	75,000
Current age of Machine (Years)	4

Proposed
Cost of New Machine	1,60,000
Installation and Shipping Fees	24,000
Annual Maintenance Cost	4,000
Annual Defect Costs	3,000
Expected Life (years)	6
Salvage Value	33,000
Annual Depreciation	25,167
Increase in Inventory Level	90,000
Increase in Current Liabilities	60,000
One time marketing consultant expense	8,500
Loss in Annual Lease Rentals	7,000
Tax Rate	21%

a)

Initial Investment of the New Machine	1,17,500
(Cost of New Machine + Installation and Shipping Fees + One time marketing consultant expense) Less Current Salvage Value of the Old Machine

b)

Yearly Cash Flows associated with New Machine
Annual Maintenance Cost	4,000
Annual Defect Costs	3,000
Annual Depreciation	25,167
Increase in Inventory Level	90,000
	1,22,167
Less: Inflows
Loss in Annual Lease Rentals	7,000
Increase in Current Liabilities	60,000
Tax Shield on Depreciation	5,285
	72,285
Annual Cash Outflow with the new Machine	49,882