Question

Weir Inc. is considering to purchase of new production machine for $100,000. although the purchase of this machine will not produce ny increase in sales revenues , it will result in a reduction of labor costs by $31,000 per year. the shipping cost is is $7,000. in addition it would cost $3,000 to install this machine properly. also because this machine is extremely efficient its purchase would necessitate an increase in inventory of $25,000. this machine has an expected life of ten years, after which it will not have no salvage value. finally to purchase the new machine it appears that the firm would have to borrow $60,000 per year. assume simplified straight line depreciation and that this machine is being depreciated down to zero , a 30% marginal tax rate , and a required rate of return of 12%.

a) what are the annual after tax cash flows associated with this project , for years 1 to 9 ?

b) what are the terminal cash flows in year 10 ?

Answer 1

Please see the below calculation for year 1 to 9

a)

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10
Machine cost (outflow)	$ (100,000.00)	$ 90,000.00	$ 80,000.00	$ 70,000.00	$ 60,000.00	$ 50,000.00	$ 40,000.00	$ 30,000.00	$ 20,000.00	$ 10,000.00
Shipping Cost(outflow)	$      (7,000.00)
Install (outflow)	$      (3,000.00)
Inventory 25000 (outflow)	$    (25,000.00)
Depreciation	$      10,000.00	$ 10,000.00	$ 10,000.00	$ 10,000.00	$ 10,000.00	$ 10,000.00	$ 10,000.00	$ 10,000.00	$ 10,000.00	$ 10,000.00
Out flow	$ (135,000.00)
Labour cost	$      31,000.00	$ 31,000.00	$ 31,000.00	$ 31,000.00	$ 31,000.00	$ 31,000.00	$ 31,000.00	$ 31,000.00	$ 31,000.00	$ 31,000.00
Borrowed money interest	$        7,200.00	$    7,200.00	$    7,200.00	$    7,200.00	$    7,200.00	$    7,200.00	$    7,200.00	$    7,200.00	$    7,200.00	$    7,200.00
Ebitda (earings change)	$ (104,000.00)	$ 23,800.00	$ 23,800.00	$ 23,800.00	$ 23,800.00	$ 23,800.00	$ 23,800.00	$ 23,800.00	$ 23,800.00	$ 23,800.00
Savings on tax (Capital Investment)	$      31,200.00
Savings on interest (12%)= 60000*12%	$        2,160.00	$    2,160.00	$    2,160.00	$    2,160.00	$    2,160.00	$    2,160.00	$    2,160.00	$    2,160.00	$    2,160.00	$    2,160.00
Additional tax for labour cost savings (31200*30%)	$      (9,360.00)	$ (9,360.00)	$ (9,360.00)	$ (9,360.00)	$ (9,360.00)	$ (9,360.00)	$ (9,360.00)	$ (9,360.00)	$ (9,360.00)	$ (9,360.00)
Profit after tax changes (Outflow - inflow)	$    (80,000.00)	$ 16,600.00	$ 16,600.00	$ 16,600.00	$ 16,600.00	$ 16,600.00	$ 16,600.00	$ 16,600.00	$ 16,600.00	$ 16,600.00
PAT Changes	$      69,400.00

b) total cash flow based on the table looks like only $69,400, we saved additional cash on depreciation. When you look at depreciation closely we saved 10000 cash in addition to 30 % 10000 i.e, 3000 saved

each year that means $13,000 cash flow saved each year when adapt machine and also this gives ore than 12 % return each year. total cash flow savings = $69,400 plus $130,000 = $209,400.