Question

7.  Problem 12.09

Click here to read the eBook: Analysis of an Expansion Project NEW PROJECT ANALYSIS You must evaluate a proposal to buy a new milling machine. The base price is $156,000, and shipping and installation costs would add another $13,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $62,400. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $8,000 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 $48,000 per year. The marginal tax rate is 35%, and the WACC is 10%. 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? 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. The cost of research is an incremental cash flow and should be included in the analysis. -Select-IIIIIIIVVItem 1 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? -Select-Yes or No

Answer 1

The initial cost of 5000 will be treated as sunk cost as it is already incurred and does not have any impact on a project starting acceptance or rejection. Hence this will not have any incremental cash flows.
Tax rate		35%
	Year-0	Year-1	Year-2	Year-3
Saving in labor cost		48,000	48,000	48,000
Less: Depreciation as per table given below		55,770	76,050	25,350
Profit before tax		(7,770)	(28,050)	22,650
Tax		(2,720)	(9,818)	7,928
Profit After Tax		(5,051)	(18,233)	14,723
Add Depreciation		55,770	76,050	25,350
Cash Profit After tax		50,720	57,818	40,073
Cost of machine			169,000
Depreciation			157,170
WDV			11,830
Sale price			62,400
Profit/(Loss)			50,570
Tax			17,700
The sale price after tax			44,701
Depreciation		Year-1	Year-2	Year-3			Total
Cost		169,000	169,000	169,000
Dep Rate		33.00%	45.00%	15.00%
Depreciation		55,770	76,050	25,350			157,170
Calculation of NPV
						10.00%
Year		Captial	Working captial	Operating cash	Annual Cash flow	PV factor	Present values
0		(169,000)	(8,000)		(177,000)	1.000	(177,000)
1				50,720	50,720	0.909	46,109
2				57,818	57,818	0.826	47,783
3		44,701	8,000	40,073	92,773	0.751	69,702
					Net Present Value		(13,407)
Since NPV is negative, the project should not be accepted