A company is evaluating the purchase of a machine to improve product quality and output levels. The new machine would cost $1.4 million and would be depreciated for tax purposes using the straight-line method over an estimated seven-year life to its expected salvage value of $100,000. The new machine would require an addition of $90,000 to working capital at the beginning of the project, which will of course be returned to the firm at the end of the project. In each year of the machine's life, the machine would increase the company's pre-tax cash receipts by $320,000. The company has a 9% cost of capital and is in the 35% marginal tax bracket.
Part 1: Prepare a Cash Flow Spreadsheet that identifies the incremental cash flows for each year of the machine's life.
Part 2: Calculate the investment's net present value (NPV).
Part 3: Calculate the investment's internal rate of return (IRR).
Part 4: Should the company purchase the machine? Why or why not?