Question

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: $    

Answer 1

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