Reference no: EM13847171
You must evaluate a proposal to buy a new machining station. The base price is $125,000, 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 3 years for $70,000. The applicable deprecation rates are 33, 45, 15 and 7 percent. The machine would require a $5,000 increase in net operating working capital (increased inventory less increased accounts payable.) There would be no effect on costs (except for depreciation), but pre-tax revenues due to this machine would be $45,500 each year. There is no inflation. The marginal tax rate is 40 percent, and the required return on capital is 12 percent. Also, the firm spent $7,000 last year investigating the feasibility of using the machine. Note that the additional revenue each year due to the Project is $45,500 (there is no inflation). Also, the rest of the firm is profitable and pays income tax; furthermore, the company has paid more than $25,000 in taxes each year for the past two years. Hence, a tax loss carryback can be used if the firm has negative EBIT from the new machine; consequently, the firm can receive a refund of taxes paid in previous years.
A. How should the $7,000 spent last year be handled?
B. What is the net cost of the machine for capital budgeting purposes, that is, the Year 0 project cash flow?
C. What are the net operating cash flows during Years 1, 2, and 3?
D. What is the terminal year cash flow?
E. Should the machine be purchased? Explain your answer. What is the NPV of the machine?
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