Ralph's Bow Works (RBW) is planning to add a new line of bow ties that will require the acquisition of a new knitting and tying machine. The machine will cost $1,000,000. It is classified as a 7-year MACRS asset and will be depreciated as such. Interest costs associated with financing the equipment purchase are estimated to be $50,000 per year.
The expected salvage value of the machine at the end of 10 years is $50,000. The decision to add the new line of bow ties will require additional net working capital of $50,000 immediately, $25,000 at the end of year 1, and $10,000 at the end of year 2. RBW expects to sell $300,000 worth of the bow ties during each of the 10 years of product life. RBW expects the sales of its other ties to decline by $25,000 (in year 1) as a result of adding this new line of ties. The lost sales level will remain constant at $25,000 over the 10-year life of the proposed project.
The cost of producing and selling the ties is estimated to be $50,000 per year. RBW will realize savings of $5,000 each year because of lost sales on its other tie lines. The marginal tax rate is 40 percent.
(Hint: See Appendix 9A for information on MACRS depreciation.)
Compute the net investment (year 0) and the net cash flows for years 1 and 10 for this project.