Question

Rump Industries is considering the purchase of a new production machine for $100,000. The introduction of the machine will result in an increase in earnings before interest and tax of $25,000 per year. Set-up of the machine will involve installation costs of $5,000 after-tax. Additionally, the machine will require workers to undergo training that will cost the company $5,000 after-tax. An initial increase in raw materials and inventory of $25,000 will also be required. The machine has an expected life of 10 years and is expected to have no salvage value at the end of its life. To purchase the new machine the company will have to borrow $80,000 at 10 per cent interest from the bank, which will require interest payments of $8,000 per year. The company will depreciate the machine straight-line over its life. The tax rate is 30 per cent and tax is paid in the year of income. Rump Industries’ required rate of return (WACC) is 12 per cent. Required: 1. Calculate the initial outlay associated with the project

2. Calculate the annual after-tax cash flows for years 1-9

3. Calculate the after-tax cash flow in year 10

4. Calculate the Net Present Value.

Answer #1

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