Problem:
The Ewert Company is evaluating the proposed acquisition of a new milling machine. The machine's base price is $108,000 and it would cost another $12,500 to modify it for special use by the firm. The machine falls into MACRS 3-year class, and it would be sold after three years for $65,000. The machine would require an increase in net working capital (inventory) of $5,500. The milling machine would have no effect on revenues, but it is expected to save the firm $44,000 per year in before-tax operating costs (mainly labor). Ewerts tax rate is 34 percent.
A) What is the initial investment outlay in Year 0 associated with this machine for capital budgeting purposes?
B) What are the incremental operating cash flows in Year 1, 2, and 3?
C) What is the terminal cash flow in Year 3?
D) If the projects required rate of return is 12 percent, should Ewert purchase the machine?
|
|
Class of Investments |
| Ownership Year |
|
3-Year |
5-Year |
7-Year |
10-Year |
|
| 1 |
|
33% |
20% |
14 |
10 |
|
| 2 |
|
45 |
32 |
25 |
18 |
|
| 3 |
|
15 |
19 |
17 |
14 |
|
| 4 |
|
7 |
12 |
13 |
12 |
|
| 5 |
|
|
11 |
9 |
9 |
|
| 6 |
|
|
6 |
9 |
7 |
|
| 7 |
|
|
|
9 |
7 |
|
| 8 |
|
|
|
4 |
7 |
|
| 9 |
|
|
|
|
7 |
|
| 10 |
|
|
|
|
6 |
|
| 11 |
|
|
|
|
3 |
|
|
|
100% |
100% |
100 |
100% |
|