(Comprehensive capital budgeting) Stan Levan is the sole trader owner of a Key Man Franchise at a local shopping centre that specialises in cutting keys and engraving trophies and jewellery items. Stan, who has a personal marginal tax rate of 40% is considering the purchase of a new computer-aided engraving machine that costs $30,000. As the new machine will engrave a larger range of trophies that Stan's old machine is able to, he will need to carry a larger range of 'Blank Trophies', which he estimates will require an increase of his inventory to about $1000. Over its five year estimated life (straight-line depreciation to a salvage value of zero), the new engraving machine is expected to generate in its first year of operation extra sales of about $15,000, as well as wastage savings of $1000. Given the recent history, Stan expects inflation for the foreseeable future to average 3% PA.
The old machine (which has a 10-year expected life) was purchased five years ago for $20,000 and Stan has depreciated it on a 10% p.a. straight line basis, down to an expected salvage value of zero. Stans cousin (who owns a small jewellery store in a country town) has told Stan that he will pay $8,000 to buy the old engraving machine if Stan wants to replace it now. During the period of which Stand has been using the old engraving machine he has carried an average inventory amount of $700 worth of trophies.
Stan has just spent $4000 on an interstate trip to see a demonstration of the new engraving machine, which he believes he had to spend to make an informed decision to purchase the new machine.
a) Detail the initial outlay amount that should be included in a capital-budgeting evaluation to purchase the new engraving machine
b) Detail the incremental cash-flow amounts that should be included in a capital budgeting evaluation to purchase the new engraving machine.
c) Detail the terminal cash-flow amounts that should be included in a capital-budgeting evaluation to purchase the new engraving machine
d) Assuming a 15% p.a. discount rate, calculate the NPV to evaluate the new engraving machine project and provide a recommendation to Stan.
Required
Note: Stan's expectations of future cash flows from the new computer-aided engraving machine are in today's dollars - hence all future cash flows will need to be adjusted to incorporate general price effects on cash flows as indicated in the question. Assume that the given discount rate has already been adjusted for any general price effects.
When preparing your responses to each part of this question, undertake this process in a manner that is practical and easy to follow.
Relevant word limit guidelines and mark allocations are as follows:
Part (a): no more than 50 words for this part of the question
Note: The reference to the new inventory level of $1,000 for the new computer-aided engraving machine refers to expected total inventory held.
Part (b): no more than 50 words for this part of the question
Part (c): no more than 50 words for this part of the question
Note: Include the final year annual incremental cash flow in your terminal cash flow calculations.
Part (d): no more than 75 words for this part of the question