MBA Corp is considering whether to expand widget production. This would require the purchase of a...

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MBA Corp is considering whether to expand widget production.This would require the purchase of a new widget-producing machineat a cost of $5,400,000. The machine would produce 450,000 widgetsper year during its useful life of three years, and would bedepreciated for tax purposes at a rate of $1,800,000 per year. Themachine would not have any salvage value. Expanding widgetproduction would also require the use of a building that couldotherwise be leased for $500,000 per year. Working capital requiredfor the new machine would be 12% of the next year’s sales. Widgetprices are $20 and are expected to remain stable. The materials andlabor required to produce a widget cost $12, and these costs arealso expected to remain stable. The corporate income tax rate is30%. The discount rate is 6% per year. (a) Forecast the incrementalcash flows resulting from the purchase of a widget machine on ayear-by-year basis and draw them on a timeline. (b) Decide whetherMBA Corp should go ahead with the purchase of the new machine.
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Answer & Explanation Solved by verified expert

3.8 Ratings (718 Votes)

The cash flows are detailed as below:

Year	0	1	2	3
No. of widgets		4,50,000	4,50,000	4,50,000
Sale value per widget		$ 20.00	$ 20.00	$ 20.00
Variable cost per widget		$ 12.00	$ 12.00	$ 12.00
Sales		$ 90,00,000.00	$ 90,00,000.00	$ 90,00,000.00
Variable costs		$ -54,00,000.00	$ -54,00,000.00	$ -54,00,000.00
Opportunity cost of building		$ -5,00,000.00	$ -5,00,000.00	$ -5,00,000.00
Depreciation		$ -18,00,000.00	$ -18,00,000.00	$ -18,00,000.00
EBIT		$ 13,00,000.00	$ 13,00,000.00	$ 13,00,000.00
Taxes @ 30%		$ -3,90,000.00	$ -3,90,000.00	$ -3,90,000.00
EBIAT		$ 9,10,000.00	$ 9,10,000.00	$ 9,10,000.00
Add back depreciation		$ 18,00,000.00	$ 18,00,000.00	$ 18,00,000.00
Gross cash flows		$ 27,10,000.00	$ 27,10,000.00	$ 27,10,000.00
Capital investment	$ -54,00,000.00			$ -
Net working capital	$ -10,80,000.00			$ 10,80,000.00
Net cash flows	$ -64,80,000.00	$ 27,10,000.00	$ 27,10,000.00	$ 37,90,000.00
NPV @ 6%	$ 16,70,651.21
IRR	18.63%

The company should go ahead with the purchase of the widget machine as the project cash flows are yielding a positive NPV and an internal rate of returb significantly higher than the discount rate.

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MBA Corp is considering whether to expand widget production.This would require the purchase of a new widget-producing machineat a cost of $5,400,000. The machine would produce 450,000 widgetsper year during its useful life of three years, and would bedepreciated for tax purposes at a rate of $1,800,000 per year. Themachine would not have any salvage value. Expanding widgetproduction would also require the use of a building that couldotherwise be leased for $500,000 per year. Working capital requiredfor the new machine would be 12% of the next year’s sales. Widgetprices are $20 and are expected to remain stable. The materials andlabor required to produce a widget cost $12, and these costs arealso expected to remain stable. The corporate income tax rate is30%. The discount rate is 6% per year. (a) Forecast the incrementalcash flows resulting from the purchase of a widget machine on ayear-by-year basis and draw them on a timeline. (b) Decide whetherMBA Corp should go ahead with the purchase of the new machine.show calculations work and calculator strokes