Question

Synlex Inc. is considering the purchase of a new machine for
**$600,000**. It would cost **$4,000** to
install the machine. It would necessitate an increase of net
working capital **120,000** at the initial time. It
will result in an increase of sales revenue by
**$210,000** and an increase of maintenance cost by
**$40,000** **per year**. The machine has
an expected life of **10** years, after which it will
have salvage value of **$50,000**. Assume
**straight-line depreciation** and the machine is
being depreciated down to **zero**. The marginal tax
rate is **40%** and the required rate of return is
**10%**.

**Required****：**

a. Calculate the machine’s **initial
investment**.

b. Calculate the **operating cash flows** over the
machine’s life.

c. Is it **favorable** for Synlex Inc. to purchase
the
machine?

(PVIFA 10%, 10 =6.1446; PVIFA 10%, 9=5.7590; PVIF 10%, 10 = 0.3855)

d. What **other elements** should Synlex consider
in deciding whether to make this investment?

Answer #1

a)

The machine's initial investment = Cost of the machine + cost of installation + increase of net working capital

Initial investment = $ 600000 + $ 4000 + $ 120000 = $ 724000

-----------------------------------------------------------------------------

b)

Depreciation expense per year = $ 55000

Operating cash flow = ( Revenue - expenses - depreciation expense ) ( 1 - tax rate ) + depreciation

Operating cash flow = ( $ 210000 - $ 40,000 - $ 55000 ) ( 1 - 0.40) + $ 55000

**Operating cash flow from year 1 to 10 = $
124000**

----------------------------------------------------------------------------------------

c)

Terminal cash flow of the asset = After tax salvage value + Recovery of working capital

**Terminal cash flow of the asset = $ 50000
( 1 - 0.40) + $ 120000 = $ 150000**

To decide if the purchase of the machine is favorable, we have to calculate the net present value of purchasing the machine.

Net present value = - $ 724000 + $ 124000 **
PVIFA ( 10%, 10 years) + $ 150000
PVIF ( 10%, 10 years)**

Net present value = - $ 724000 + $ 124000 **
**6.1446 + $ 150000 **
0.3855**

**Net present value = $ 95755.4
$ 95755**

**----------------------------------------------------------------------------------------------------**

**d)**

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