Question

A company is considering the purchase of a new machine that will enable it to increase...

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

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