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.

Initial investment = Purchasing cost of machine + Installation + Net working capital

                              = $ 600,000 + $ 4,000 + $ 120,000 = $ 724,000

b.

Increase in sales revenue	$210,000
Less: Maintenance cost	40,000
EBTD	170,000
Less: Depreciation ($604,000/10)	60,400
EBT	109,600
Tax @ 40 %	43,840
Net income	65,760
Add: Depreciation	60,400
Net annual cash flow	$126,160

c.

NPV = PV of future cash flow – Initial investment

        = $ 126,160 x PVIFA (10 %, 10) + [$ 120,000 + $ 50,000 x (1-0.4)] x PVIF (10 %, 10) - $ 724,000

         = $ 126,160 x 6.1446 + [$ 120,000 + ($ 50,000 x 0.6)] x 0.3855 - $ 724,000

         = $ 775,202.736 + ($ 120,000 + $ 30000) x 0.3855 - $ 724,000

          = $ 775,202.736 + ($ 150000 x 0.3855) - $ 724,000

           = $ 775,202.736 + $ 57,825 - $ 724,000

            = $ 833,027.736 - $ 724,000

           = $ 109,027.736

As NPV is positive, it is Favorable to purchase the machine.

d.

Other element like discounted payback period , IRR and MIRR can be consider in deciding the whether to make to the investment.