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 3year 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.
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  (66,3008,400)35% +4,500
= $50,535
Hence, annual cash flow in year 3 = 50,535+44,650 = $95,185
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