Assume you are the owner and operator of a textile manufacturer. You must evaluate the proposal of buying a new machine for your factory. The company has already spent $5,000 investigating the feasibility of using the machine. The price of the equipment is $120,000. Shipping and installation will cost an additional $10,000. The machine falls under the MACRS 3- year class; the applicable depreciation rates are 33%, 45%, 15%, and 7%. After using the machine for three years it would be sold for $71,500. The machine would require an increase in net operating working capital of $6,000. The machine would not impact revenues, but it would cause pre-tax labor costs to decline by $42,500 per year. The marginal tax rate is 35% and the cost of capital is 11%.
a. How should the $5,000 spent on a feasibility analysis be handled?
b. What is the initial investment cost for the machine (Year 0 cash flow)?
c. What are the annual cash flows for years 1, 2 and 3?
d. Find the project’s NPV, IRR and MIRR.
e. Should you buy the machine? Explain your answer.