Question

Mickey's Supply is looking to upgrade technology to allow for faster service. The price of the machine is $210,000. Installation costs $20,000. They expect the increased sales (net of expenses except for depreciation) or EBITDA to be 80,000 for year 1. 130,000 for year 2. 70,000 for year 3. The machine can be sold for $40,000 at the end of the project. Tax 40%.
a. What WACC should be used?
b. What is the initial investment?
c. If MACRS for 3 years is added to the problem. what would be the operating cash flows for years 1-3? Show work.

They have $500,000 in loans. $1500000in equity rs 13%. Tax rate 40%.
after tax cost of debt = 6%*(1-0.40) =3.60%.
For debt the amount is 500,000. Is 0.25 * COC% 3.60%=0.90%
For the equity 1500000. Is 0.75* COC%.13%=9.75%.
Total amount is 20000000.
WACC = 10.65

Answer 1

1)

WACC:

We = 1,500,000 / (1,500,000 + 500,000) = 75%

Wd = 500,000 / (1,500,000 + 500,000) = 25%

WACC = We*rs + Wd*rd*(1 - tax)

= (0.75*13%) + (0.25*6%*(1-0.4))

= 10.65%

2)

Initial investment = Price + installation cost

= 210,000 + 20,000

= $230,000

3)

MACRS depreciation rates

Year 1 = 33.33%

Year 2 = 44.45%

Year 3 = 14.81%

Depreciation base = 230,000

OCF:

(salvage value after tax = 30,871.20 (40,000 - [(40,000 - (230000*7.41%)]*40%). we have to add salvage value to year 3 Operating cash flow to find net cash flow in year 3 = 59218.90 + 30,871.20 = 90,036.10. this cash flow need to be consider for calculating NPV)