A company is considering the purchase of a new machine that will enable it to increase its expected sales. The machine will have a direct cost of $100,000. In addition, the machine must be installed and tested. The costs of installation and testing will amount to $40,000. The machine will be depreciated using 5-years MACRS.
The equipment will be operated for 6 years. The sales in the first year of operation are expected to be $200,000. Then, sales will grow by 5% per year until the sixth year. The annual operating costs (before depreciation) will consist of fixed operating costs of $25,000 plus variable operating costs equal to 75% of sales.
To support the increased level of production, the inventory of raw materials will have to be increased from $40,000 to $50,000 when the machine is purchased. The additional inventory will be carried until the machine is scrapped following the 6 years of operation.
At the end of the 6-year operating life of the project, it is assumed that the equipment will be sold for $60,000. The tax rate is 40%.
If the new machine is purchased, it will be financed by borrowing the required funds at an interest rate of 8%. The company's weighted average cost of capital is 9.50%.
Build a capital budgeting model and answer the following questions:
1) What is the operating cash flow in year 6?
2) What is the initial outlay in year 0?
3) What is the terminal cash flow in the last year of operation?
4) What is the after tax salvage at the terminal year?
5) What is the tax on gain (loss) from the sale of the machine at the terminal year?
6) Calculate NPV, IRR, and PI for the project.
7) Using data table in excel, perform a sensitivity analysis of annual sales growth rate on IRR (use the following sales growth rate in your analysis: 10%, 8%, 6%, 4%,.......,-6%)