Response to the following questions:
1. Carter Air Lines is now in the terminal year of a project. The equipment originally cost $20 million, of which 80 percent has been depreciated. Carter can sell the used equipment today to another airline for $5 million, and its tax rate is 40 percent. What is the equipment's after-tax net salvage value?
2. The Campbell Company is evaluating the proposed acquisition of a new milling machine. The machine's base price is $108,000, and it would cost another $12,500 to modify it for special use. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $65,000. The machine would require an increase in net working capital (inventory) of $5,500. The milling machine would have no effect on revenues, but it is expected to save the firm $44,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 35 percent.
a. What is the net cost of the machine for capital budgeting purposes? (That is, what is the Year 0 net cash flow?)
b. What are the net operating cash flows in Years 1, 2, and 3?
c. What is the additional Year 3 cash flow (that is, the after-tax salvage and the return of working capital)?
d. If the project's cost of capital is 12 percent, should the machine be purchased.