1. The Chung Chemical Corporation is considering the purchase of a chemical analysis machine. Although the machine being considered will result in an increase in earnings before interest and taxes of $40,000 per year, it has a purchase price of $140,000, and it would cost an additional $5,000 to properly install the machine. In addition, to properly operate the machine, inventory must be increased by $7,000. This machine has an expected life of 10 years, after which it will have no salvage value. Also, assume simplified straight-line depreciation and that this machine is being depreciated down to zero, a 31% marginal tax rate, and a required rate of return of 13%.
a. What is the initial outlay associated with this project?
b. What are the annual after-tax cash flows associated with this project for years 1 through 9?
c. What is the terminal cash flow in year 10 (what is the annual after-tax cash flow in year 10 plus any additional cash flows associated with the termination of the project)?
d. Should this machine be purchased?
2. Raymobile Motors is considering the purchase of a new production machine for $450,000. The purchase of this machine will result in an increase in earnings before interest and taxes of $140,000 per year. To operate his machine properly, workers would have to go through a brief training session that would cost $50,000 afier taxes. It would cost $6,000 to install the machine properly. Also, because the machine is extremely efficient, its purchase would necessitate an increase in inventory of $25,000. This machine has an expected life of 10 years, afier which it will have no salvage value. Assume simplified straight-line depreciation and that this machine is being depreciated down to zero, a 34% marginal tax rate, and a required rate of return of 17%.
a. What is the initial outlay associated with this project?
b. What are the annual afier-tax cash flows associated with this project for years 1 through 9?
c. What is the terminal cash flow in year 10 (what is the annual afier-tax cash flow in year 10 plus any additional cash flows associated with the termination of the project)?
d. Should the machine be purchased?