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The Madison Prefabricated Buildings Co. is considering adding a new line to its

product mix. Marcy Mulholland is to conduct a capital budgeting analysis on the

project. The production line would be set up in unused space in Madison's main

plant. The space could be leased out at $25,000 per year. The machinery's invoice

price is approximately $200,000; $10,000 in shipping charges would be required;

and it would cost $30,000 to install the machinery. The firm's inventories would have

to be increased by $25,000 to handle the new line, but its accounts payable would

rise by $5,000. The machinery has an economic life of 4 years, and qualifies as a

MACRS 3-year asset. The machinery is expected to have a salvage value of

$25,000 after 4 years. The new line would generate $125,000 in additional revenues

in each of the next 4 years. The firm's marginal tax rate is 40% and its required

return is 10 percent.

a.

Construct the cash flows for each year by modifying an income statement. Be able

to describe why you treated each cash flow as you did.

b.

If the new product line decreases sales of the firm's other lines by $50,000 per year,

should this information be included in the analysis? If so, how would Ms. Mulholland

do it?

c.

Determine whether the machine should be purchased. Explain your decision.

d.

How much taxes did you save by having depreciation expense?

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