Question

1-     Coffee Shop is considering a three-year project to purchase a new machine press to improve its production efficiency. Six months ago, it contracted with Dr. right to provide a thorough study of whether there was a need for this three-year efficiency project. The report was delivered one month ago and it’s cost was $25,000. The report suggests that the company should go ahead with the project subject to Massey’s financial analysis. Buying a new machine press for $400,000 is estimated to result in $120,000 in annual pretax cost savings. The press falls in the MACRS five-year class and it will have a salvage value at the end of the project of $85,000. At time 0, the press will also require an additional investment in inventory of $9,000. Other current accounts will not be affected. If the company’s tax rate is 40% and its WACC is 10%, determine the company’s free cash flow for each year (i.e. from time 0 to time 3)?    The MACRS schedule is as follows:

Year	5-year Class
1	20%
2	32%
3	19.2%
4	11.52%
5	11.52%
6	5.76%

Answer 1

Free cash flow calculation is as per Excel sheet

Year	0	1	2	3
Initial Investment	400000
Additional inventory	9000
Report cost	25000
Pretax Cost Savings		120000	120000	120000
Depreciation MACRS Rates		20%	32%	19.20%
Depreciation = Depreciation rate * Initial Investment		80000	128000	76800
EBIT= After tax Cost savings - Depreciation		40000	-8000	43200
Tax = Tax rate * EBIT		16000	-3200	17280
EAT= EBIT-TAXES		24000	-4800	25920
Depreciation		80000	128000	76800
after tax salvage value= salvage value* ( 1 -tax rate)				51000
Free cash flow= EAT + Depreciation + After tax Salavge value	-434000	104000	123200	153720