A company is evaluating the pr
A company is evaluating the proposed acquisition of a newmachine. The machine’s base price is $108,000, and it would costanother $12,500 to modify it for special use. Depreciation ratesare 0.33, 0.45, and 0.15 for years 1, 2, and 3, respectively, andit would be sold after 3 years for $65,000. The machine wouldrequire an increase in net working capital (inventory) of $5,500.The machine would have no effect on revenues, but it is expected tosave the firm $44,000 per year in before-tax operating costs,mainly labor. The company’s marginal tax rate is 35%.
a. What is the net cost of the machine for capital budgetingpurposes? (That is, what is the Year-0 net cash flow?)
b. What are the net operating cash flows in Years 1, 2, and3?
c. What is the additional Year-3 cash flow (i.e., the after-taxsalvage and the return of
working capital)?d. If the project’s cost of capital is 12%, should the machine bepurchased?
Answer:
| Answer 1 | ||||||||||
| Net cash flow at time 0=Net working cpitalInvestment +fixed capital Investment | ||||||||||
| Net cash outflow=108000+12500+5500 | ||||||||||
| Net cash outflow= | 126,000 | |||||||||
| Answer 2 | Year | Dep rate | Dep expense | |||||||
| Net asset value= | 120,500 | 1 | 33% | 39,765 | ||||||
| 2 | 45% | 54,225 | ||||||||
| 3 | 15% | 18,075 | ||||||||
| Total | 112,065 | |||||||||
| Book value at year 3 | 120500-112065 | |||||||||
| Book value at year 3 | 8,435 | |||||||||
| 1 | 2 | 3 | ||||||||
| Before tax operating cost | 44,000 | 44,000 | 44,000 | |||||||
| Less tax | (15,400) | (15,400) | (15,400) | |||||||
| After tax operating cost | 28,600 | 28,600 | 28,600 | |||||||
| add depreciation | 39,765 | 54,225 | 18,075 | |||||||
| Cash flow | 68,365 | 82,825 | 46,675 | |||||||
| Answer 3 | ||||||||||
| additional year 3 cash flow=salvage vale+networking capital-tax(salvage value-book value) | ||||||||||
| Year 3 additional cash flow= | 5500+65000-0.35*(65000-8435) | |||||||||
| Year 3 additional cash flow= | 50,702 | |||||||||
| Answer 4 | Project is acceptable because of positive NPV | |||||||||
| Method 1 | ||||||||||
| calculate NPV Using NPV Function in excel andsubtract Initial cash Outflow from it | ||||||||||
| Year | Machine A | |||||||||
| 0 | (126,000) | |||||||||
| 1 | 68,365 | |||||||||
| 2 | 82,825 | |||||||||
| 3 | 97,377 | |||||||||
| Discount rate | 12% | |||||||||
| NPV= | 70,378.96 | |||||||||
| Method 2 | ||||||||||
| Using Financial Calculator | ||||||||||
| Press CF | ||||||||||
| CF0= | (126,000) | (Press Enter and scroll down) | ||||||||
| CF1= | 68,365 | (Press Enter and scroll down Twice) | ||||||||
| CF2= | 82,825 | (Press Enter and scroll down Twice) | ||||||||
| CF3= | 97,377 | (Press Enter and scroll down Twice) | ||||||||
| Press NPV | ||||||||||
| Interest= | 12% | (Press Enter and scroll down) | ||||||||
| Press CPT+NPV | ||||||||||
| NPV= | 70,378.96 | |||||||||
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