Question

You must evaluate a proposal to buy a new milling machine. The base price is \$102,000,...

You must evaluate a proposal to buy a new milling machine. The base price is \$102,000, and shipping and installation costs would add another \$18,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for \$66,300. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a \$4,500 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 \$59,000 per year. The marginal tax rate is 35%, and the WACC is 10%. Also, the firm spent \$4,500 last year investigating the feasibility of using the machine.

1. What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Enter your answer as a positive value. Round your answer to the nearest cent.
\$
2. 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 cent.
Year 1: \$
Year 2: \$
Year 3: \$

Initial Investment Outlay:

Cost = \$102,000

Modification Cost = \$18,000

Increase in Net working Capital = \$4,500

Initial Outlay = \$124,500

Calculation of annual cash flows:

 Year 1 Year 2 Year 3 Savings in cost 59,000 59,000 59,000 Less: Depreciation 39,600 54,000 18,000 Net Income 19,400 5,000 41,000 Tax @35% 6,790 1,750 14,350 After Tax 12,610 3,250 26,650 Cash Flow = After tax income+ depreciation \$52,210 \$57,250 \$44,650

Additional Cash flow in year 3 = Salvage Value net of tax + Working capital Release

= 66,300 - (66,300-8,400)35% +4,500

= \$50,535

Hence, annual cash flow in year 3 = 50,535+44,650 = \$95,185