Question

You must evaluate a proposal to buy a new milling machine. The base price is $113,000, and shipping and installation costs would add another $18,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $56,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $7,500 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 $60,000 per year. The marginal tax rate is 35%, and the WACC is 8%. Also the firm spent $4500 last year investigating the feasability of using machine.

a. How should the $4500 spent last year be handled? Choose the correct number

1. 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.

2. Last year expenditure is considered an oppoturnity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.

3. Last Year expenditure is considered a sunk cost and does not represent an incremental cash flow. hence, it should not be included in the analysis.

4. the cost of research is an incremental cash flow and should be included in the analysis.

5. only the tax effect of the research expenses should be included in the analysis.

B. what is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the year 0 project cash flow? enter your answer as a positive value. Round your answer to the nearest cent.

C. What are the project's annual cash flow during year 1,2 and 3? do not round intermidiate calculations. Round your answers to the nearest cent.

D. Should the machine be purchased? Yes or No.

Answer 1

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