Garcia's Truckin Inc. is considering the purchase of a new production machine for $150,000. The purchase of this machine will result in an increase in earnings before interest and taxes of $50,000 per year. To operate the machine properly, workers would have to go through a brief training session that would cost $3,000 after taxes. It would cost $5,000 to install the machine properly. Also, because this machine is extremely efficient, it's purchase would necessitate an increase in inventory of $20,000. This machine has an expected life of 10 years, after which it would have no salvage value. Finally, to purchase the new machine, it appears that the firm would have to borrow $100,000 at 9 percent interest from its local bank, resulting in additional interest payments of $9,000 per year. Assume simplified straight-line depreciation and that the machine is being depreciated down to zero, a 36 percent marginal tax rate and a required rate of return of 13 percent.
a) What is the initial outlay associated with this project?
b) What are the annual after-tax cash flows associated with this project for years 1 through 9?
c) What is the terminal cash flow in year 10? (What is the annual after-tax cash flow in year 10 plus any additional cash flows associated with the termination of the project)?
Should the machine be purchased?