Question

A company is considering the purchase of a new machine that will enable it to increase its expected sales. The machine will have a price of $100,000. In addition, the machine must be installed and tested. The costs of installation and testing will amount to $10,000. The machine will be depreciated using 3-years MACRS. (Use MACRS table from class excel exercise by copying the table and pasting it) The equipment will be operated for 5 years. The sales in the first year of operation are expected to be $260,000. Then, sales will grow by 3% a year. The annual operating costs (before depreciation) will consist of fixed operating costs of $25,000 plus variable operating costs equal to 70% of sales.

To support the increased level of production, the inventory of raw materials will have to be increased from $30,000 to $50,000 when the machine is purchased. The additional inventory will be carried until the machine is scrapped following the 5 years of operation.

At the end of the 5-year operating life of the project, it is assumed that the equipment will be sold for $40,000.

The tax rate is 40% and the company’s weighted average cost of capital is 9%.

Build a capital budgeting model to answer the following questions:

1) What is the operating cash flow in year 1-5?

2) What is the initial outlay in year 0?

3) What is the after tax salvage at the terminal year?

4) Calculate NPV and PI for the project.

Check points:

NI in year 2 = $3,834

IRR = 26.73%

Year	3-year	5-year	7-year	10-year
1	0.333	0.2	0.143	0.1
2	0.445	0.32	0.245	0.18
3	0.148	0.192	0.175	0.144
4	0.074	0.115	0.125	0.115
5		0.115	0.089	0.092
6		0.058	0.089	0.074
7			0.089	0.066
8			0.045	0.066
9				0.065
10				0.065
11				0.033

Answer 1