Question

Western Textiles (WT) is considering an investment in a new weaving machine. This machine is for a growth opportunity, so the new machine will not replace an existing machine. The new machine is priced at $214,000 and will require installation costing $26,000. WT plans to use the machine for 4 years, while it will be depreciated using the MACRS method over its 3-year class life, and then plans to sell the machine at its expected salvage value of $80,000 at the end of Year 4. The machine will require a $20,000 increase in net working capital. It is expected to generate additional sales revenues of $125,000 per year, but its use also will increase annual cash operating expenses by $55,000. WT’s required rate of return is 10 percent, and its marginal tax rate is 40 percent. The machine’s book value at the end of Year 4 will be $0, so WT will have to pay taxes on the $80,000 salvage value. Enter answers in numeric format with no special characters or symbols.

What is the initial cash outflow at T0 for this project?

What is the Depreciation expense for year 1 through year 4?

What is the supplemental operating cash flow for Year 1 through year 4?

What is the Net Present Value for this project?

What is the Internal Rate of Return for the project?

Answer 1

WT	0	1	2	3	4
MACRS %		33.33%	44.45%	14.81%	7.41%
Investment	-240000
NWC	-20000				20000
Salvage					80000
Revenues		125000	125000	125000	125000
Costs		-55000	-55000	-55000	-55000
Depreciation		-79992	-106680	-35544	-17784
EBT		-9992	-36680	34456	52216
Tax (40%)		3996.8	14672	-13782.4	-20886.4
Net Income		-5995.2	-22008	20673.6	31329.6
Cash Flows	-260000	73996.8	84672	56217.6	117113.6
NPV	($526.04)
IRR	9.91%

Working capital will be recovered at end of the project.

Depreciation = MACRS % x Investment

Cash Flow = Investment + NWC + Salvage x (1 - tax) + Net Income + Depreciation

Initial cash flow = -260,000

NPV and IRR can be calculated using the same function on a calculator or excel.