Problem:
XYZ Inc. needs to install a new manufacturing machine. The base price is $100,000. Installation costs are $10,000. After 3 years the machine will be sold for $75,000. Applicable depreciation rates are 33 percent, 45 percent, 15 percent, and 7 percent. The machine would require a $5,000 increase in net operating working capital (increased inventory less increased accounts payables). Revenue would not be affected. Pretax labor costs would decline by $40,000 per year. The marginal tax rate is 40 percent, and the WACC is 10 percent. Also, the firm spent $7,000 in feasibility tests.
Required:
Question 1. $7,000 was spent last year. How should this be handled?
Question 2. For capital budgeting purposes, what is the initial investment outlay for the machine? That is, what is the Year 0 project cash flow?
Since the $7k was for feasibilty testis, there are "sunk costs" that will nobe recovered. This are not relevant to the capital budgeting decisions and cannot be recovered. Base price + Installation + $5k to increase working capital makes Cash Flow @ Year 0 $115,000. Explain in detail and please provide calculation and step by step solution.