NEW PROJECT ANALYSIS You must evaluate a proposal to buy a newmilling machine. The base price is $125,000, and shipping andinstallation costs would add another $14,000. The machine fallsinto the MACRS 3-year class, and it would be sold after 3 years for$81,250. The applicable depreciation rates are 33%, 45%, 15%, and7%. The machine would require a $4,000 increase in net operatingworking capital (increased inventory less increased accountspayable). There would be no effect on revenues, but pretax laborcosts would decline by $37,000 per year. The marginal tax rate is35%, and the WACC is 10%. Also, the firm spent $5,000 last yearinvestigating the feasibility of using the machine.

A How should the $5,000 spent last year be handled?

a Last year's expenditure is considered as a sunk cost and doesnot represent an incremental cash flow. Hence, it should not beincluded in the analysis.

bThe cost of research is an incremental cash flow and should beincluded in the analysis.

c Only the tax effect of the research expenses should beincluded in the analysis.

d Last year's expenditure should be treated as a terminal cashflow and dealt with at the end of the project's life. Hence, itshould not be included in the initial investment outlay.

e Last year's expenditure is considered as an opportunity costand does not represent an incremental cash flow. Hence, it shouldnot be included in the analysis.

B What is the initial investment outlay for the machine forcapital budgeting purposes, that is, what is the Year 0 projectcash flow? Round your answer to the nearest cent. $

C What are the project's annual cash flows during Years 1, 2,and 3? Round your answer to the nearest cent. Do not round yourintermediate calculations. Year 1 $ Year 2 $ Year 3

Should the machine be purchased? Yes/ No