Stanton Inc. is considering the purchase of a new machine which will increase earnings before depreciation and taxes by $1,000 annually but will not affect the cost (i.e., will increase revenues but will not affect the cost). The price of this machine including modification and installations is $50,000. Stanton will use the MACRS method to depreciate the machine and it expects to sell the machine at the end of its 4-year operating life for $10,000 before taxes. In addition, there would be an increase of $3000 in networking capital. Stanton's marginal tax rate is 40% and it uses a 10% cost of capital to evaluate projects of this type.
Year MACRS 3-year class
Recovery allowance percentage 33%
1 33%
2 45%
3 15%
4 7%
a) What is the initial cash outlay (at time zero)?
b) What are the operating cash flows (OCF) in years 1 through 4?
c) What is the terminal cash flow at the end of the 4th year?
d) Show your findings in parts a-c on the timeline.
e) What is the project's NPV? f) Given the NPV you calculated, should the firm undertake the project?