Question

# ​(Calculating project cash flows and​ NPV)  Raymobile Motors is considering the purchase of a new production...

​(Calculating project cash flows and​ NPV)  Raymobile Motors is considering the purchase of a new production machine for \$550,000. The purchase of this machine will result in an increase in earnings before interest and taxes of \$180,000 per year. To operate this machine​ properly, workers would have to go through a brief training session that would cost \$23,000 after tax. In​ addition, it would cost \$6,000 after tax to install this machine correctly. ​ Also, because this machine is extremely​ efficient, its purchase would necessitate an increase in inventory of \$24,000. This machine has an expected life of 10 years, after which it will have no salvage value. Assume simplified​ straight-line depreciation, that this machine is being depreciated down to​ zero, a 36 percent marginal tax​ rate, and a required rate of return of12percent.

a.  What is the initial outlay associated with this​ project? (Round to nearest dollar)

b.  What are the annual​ after-tax cash flows associated with this project for years 1 through 9​?

c.  What is the terminal cash flow in year 10 (that is, the annual​ after-tax cash flow in year 10 plus any additional cash flows associated with termination of the​ project)?

d.  Should this machine be​ purchased?

a.Initial Outlay is calculated as follows:

Purchase cost = \$550,000

Training cost = \$23,000

Installation cost = \$6,000

Increase in Inventory = \$24,000

Initial Outlay = \$603,000

b.Calculation of annual after tax cash flows:

Annual EBIT = \$180,000

less: tax @36% = \$64,800

Earnings after tax = \$115,200

Add: Depreciation (non-cash) = (550,000+6,000)/10 = \$55,600

Annual cash flow = \$170,800

c.Terminal cash flow:

Annual cash flow = \$170,800

Add: Release if inventory = \$24,000

Terminal Cash flow in Year 10 = \$194,800

d.NPV = Present Value of cash inflows - present value of cash outflows

= 170,800*PVAF(12%, 10 years) + 24,000*PVF(12%, 10 years) - 603,000

= 170,800*5.65022 + 24,000*0.32197-603,000

= \$369,785.37

Hence, the machine should be purchased since positive NPV

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