Question: You have been asked by the president of your company to evaluate a proposed acquisition of equipment that will cost $120,000, with another $30,000 for installation. This new equipment will replace your current equipment which is fully depreciated which currently has a $20,000 salvage value, but would have no salvage value if it were to be kept in use for another 5 years. The new equipment may be depreciated using a five-year straight-line depreciation method. The equipment will have a salvage value of $30,000 at the end of the fifth year. Initially, the following changes would occur to net working capital: inventory will increase by $10,000 and Accounts Payables by $5,000. This project will decrease the company's costs by $20,000 per year, while increasing revenues by $80,000 due to filling back-orders that had often become lost sales. The current operating costs are 60 percent of revenues (hint: remember to adjust the resulting operating income by the cost savings) and the firm's marginal tax rate is 40 percent.
Calculate:
a. The initial outlay
b. The incremental operating cash flows for each of the 5 years
c. The terminal cash flows in year 3
d. Using the project's required rate of return of 14%, should the project be accepted?