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MBA Corp is considering whether to expand widget production. This would require the purchase of a new widget-producing machine at a cost of $5,400,000. The machine would produce 450,000 widgets per year during its useful life of three years, and would be depreciated for tax purposes at a rate of $1,800,000 per year. The machine would not have any salvage value. Expanding widget production would also require the use of a building that could otherwise be leased for $500,000 per year. Working capital required for the new machine would be 12% of the next year’s sales. Widget prices are $20 and are expected to remain stable. The materials and labor required to produce a widget cost $12, and these costs are also expected to remain stable. The corporate income tax rate is 30%. The discount rate is 6% per year.

(a) Forecast the incremental cash flows resulting from the purchase of a widget machine on a year-by-year basis and draw them on a timeline.

(b) Decide whether MBA Corp should go ahead with the purchase of the new machine.

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Deanna Hettinger
Deanna HettingerLv2
28 Sep 2019

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