Question

Momma is considering investing in new 3-D printing capabilities in order to produce certain parts more efficiently. This equipment will cost $400,000 and is estimated to produce income of $40,000 per year over the 5 -years the equipment will be useful before needing to be replaced. Projected cash flows from the asset are estimated to be $10,000 in year one, $20,000 in years two through four and $12,000 in year 5. Annual depreciation on the machine is based on straight line depreciation and no residual value. The machine will need to be recalibrated at the end of each year at a cost of $2,000.

1. Should Momma move forward with the investment? (for credit you must show numerical rationale for your answer).
2. Whether you said Momma should or should not move forward with the investment, what about from the overall company standpoint – should the investment be undertaken?
3. What are four things to consider other than your quantitative analysis in making this type of investment decision.

Answer 1

Initial Cash Flow = -$400,000

CF1 = 10,000

CF2 = 20,000

CF3 = 20,000

CF4 = 20,000

CF5 = 12,000

Depreciation Expense = 80,000 per year

Since the sum of all cash flows (ie. $82,000) is less than the initial cash outlay ($400,000) so the present value will definitely be negative at any +ve discount rate. Hence Momma should not take up this project.

b) If the company is profiatble and pays taxes, then it might make sense to take up this project. This is beacuse the resulting depriciation expense will help reduce the taxable income and ultimately result in some tax savings.