Question

You must evaluate a proposal to buy a new milling machine. The purchase price of the milling machine, including shipping and installation costs, is $152,000, and the equipment will be fully depreciated at the time of purchase. The machine would be sold after 3 years for $71,000. The machine would require a $3,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $55,000 per year. The marginal tax rate is 25%, and the WACC is 10%. Also, the firm spent $4,500 last year investigating the feasibility of using the machine.

- How should the $4,500 spent last year be handled?
- The cost of research is an incremental cash flow and should be included in the analysis.
- Only the tax effect of the research expenses should be included in the analysis.
- Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay.
- Last year's expenditure is considered an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.
- Last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.

-Select-IIIIIIIVVItem 1 - What is the initial investment outlay for the machine for
capital budgeting purposes after the 100% bonus depreciation is
considered, that is, what is the Year 0 project cash flow? Enter
your answer as a positive value. Round your answer to the nearest
dollar.

$ - What are the project's annual cash flows during Years 1, 2, and
3? Do not round intermediate calculations. Round your answers to
the nearest dollar.

Year 1: $

Year 2: $

Year 3: $ - Should the machine be purchased?

-Select-YesNo

Answer #1

1.

Last year's expenditure is considered a sunk cost and does not
represent an incremental cash flow. Hence, it should not be
included in the analysis.

2.

=-152000+152000*25%-3500=-117500.00

3.

=(55000-152000/3)*(1-25%)+152000/3=53916.6666666667

4.

=(55000-152000/3)*(1-25%)+152000/3=53916.6666666667

5.

=(55000-152000/3)*(1-25%)+152000/3+3500+71000*(1-25%)=110666.666666667

6.

NPV=-152000+152000*25%-3500+((55000-152000/3)*(1-25%)+152000/3)/10%*(1-1/1.1^3)+3500/1.1^3+71000*(1-25%)/1.1^3=59219.8847983973

Yes

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