Question: You have been asked by the president of Ellis Construction Company, headquartered in Toledo, to evaluate the proposed acquisition of a new earthmover. The mover's basic price is $50,000, and it will cost another $10,000 to modify it for special use by Ellis Construction. Assume that the earthmover falls into the MACRS 3-year class. (See Table 10A.2 at the end of Chapter 10 for MACRS recovery allowance percentages.) It will be sold after three years for $20,000, and it will require an increase in net working capital (spare parts inventory) of $2,000. The earthmover purchase will have no effect on revenues, but it is expected to save Elli $20,000 per year in before-tax operating costs, mainly labor. Ellis's marginal tax rate is 40 percent.
a. What is the company's net initial investment outlay if it acquires the earthmover? (That is, what is the Year 0 net cash flow?)
b. What are the incremental operating cash flows in Years 1, 2, and 3?
c. What is the terminal cash flow in Year 3?
d. If the project's required rate of return is 10 percent, should the earthmover be purchased?