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Assume you are the owner and operator of a textile manufacturer. You must evaluate the proposal of buying a new machine for your factory. The company has already spent $5,000 investigating the feasibility of using the machine. The price of the equipment is $120,000. Shipping and installation will cost an additional $10,000. The machine falls under the MACRS 3-year class; the applicable depreciation rates are 33%, 45%, 15%, and 7%. After using the machine for three years it would be sold for $71,500. The machine would require an increase in net operating working capital of $6,000. The machine would not impact revenues, but it would cause pre-tax labor costs to decline by $42,500 per year. The marginal tax rate is 35% and the cost of capital is 11%.

a. How should the $5,000 spent on a feasibility analysis be handled?

b. What is the initial investment cost for the machine (Year 0 cash flow)?

c. What are the annual cash flows for years 1, 2 and 3?

d. Find the project’s NPV, IRR and MIRR.

e. Should you buy the machine? Explain your answer.

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Jarrod Robel
Jarrod RobelLv2
29 Sep 2019

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Dayman Inc. has asked you to evaluate a proposal to buy a new costume machine. The base price is $110,000, and shipping and installation costs would add another $15,000. The machine falls into the MACRS 3-year class, and it would be sold after another 3 years for $65,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $5,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $49,000 per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $15,000 last year investigating the feasibility of using the machine. What are the project’s cash flows at year 1 (1 point) and year 2 (1 point)?

Problem 12-9
New project analysis

You must evaluate a proposal to buy a new milling machine. The base price is $164,000, and shipping and installation costs would add another $7,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $82,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $7,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $41,000 per year. The marginal tax rate is 35%, and the WACC is 11%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.

How should the $5,000 spent last year be handled?

The cost of research is an incremental cash flow and should be included in the analysis.

Only the tax effect of the research expenses should be included in the analysis.

Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay.

Last year's expenditure is considered an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.

Last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.


-Select-IIIIIIIVVItem 1

What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent.
$

What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent.
Year 1 $
Year 2 $
Year 3 $

Should the machine be purchased?
-Select-yesno

You must evaluate a proposal to buy a new milling machine. The base price is $167,000, and shipping and installation costs would add another $9,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $108,550. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $6,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $38,000 per year. The marginal tax rate is 35%, and the WACC is 10%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.

How should the $5,000 spent last year be handled?

I. The cost of research is an incremental cash flow and should be included in the analysis.

II. Only the tax effect of the research expenses should be included in the analysis.

III. Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay.

IV. Last year's expenditure is considered an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.

V. Last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.

I, II, III, IV or V?

What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent.
$

What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent.
Year 1 $
Year 2 $
Year 3 $

Should the machine be purchased?

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