You are considering adding a new item to your company’s line of products. The machine required...

Free

90.2K

Verified Solution

Question

Finance

You are considering adding a new item to your company’s line ofproducts. The machine required to manufacture the item costs$600,000. The shipping costs are $2,000 and the installation costsare $28,000. It falls into the three-year MACRS classification. TheMACRS three-year depreciation rates are 33%, 45%, 15%, and 7%. Thenew item would immediately require an investment in NWC of $55,000.You plan to market the items for three years and then sell themachine for $90,000. You expect to sell 25,000 items per year at aprice of $22. You expect variable manufacturing costs to be $20 peritem and NO fixed costs will be incurred. If the tax rate is 40%and your weighted average cost of capital is 14% per year, what isthe net present value of selling the new item? What should youdo?

Answer & Explanation Solved by verified expert

4.2 Ratings (637 Votes)

Time line		0	1	2	3



Cost of new machine		-630000
Initial working capital		-55000
=Initial Investment outlay		-685000

3 years MACR rate			33.00%	45.00%	15.00%	7.00%
Unit sales			25000	25000	25000
Profits	=no. of units sold * (sales price - variable cost)		50000	50000	50000


-Depreciation	=Cost of machine*MACR%		-207900	-283500	-94500	44100	=Salvage Value

=Pretax cash flows			-157900	-233500	-44500
-taxes	=(Pretax cash flows)*(1-tax)		-94740	-140100	-26700
+Depreciation			207900	283500	94500
=after tax operating cash flow			113160	143400	67800

reversal of working capital					55000

+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				-54000
+Tax shield on salvage book value	=Salvage value * tax rate				17640
=Terminal year after tax cash flows					18640

Total Cash flow for the period		-685000	113160	143400	86440
Discount factor=	(1+discount rate)^corresponding period	1	1.14	1.2996	1.481544
Discounted CF=	Cashflow/discount factor	-685000	99263.16	110341.6	58344.538
NPV=	Sum of discounted CF=	-417050.6607

Donot make the investment as NPV is negative

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member

Transcribed Image Text

You are considering adding a new item to your company’s line ofproducts. The machine required to manufacture the item costs$600,000. The shipping costs are $2,000 and the installation costsare $28,000. It falls into the three-year MACRS classification. TheMACRS three-year depreciation rates are 33%, 45%, 15%, and 7%. Thenew item would immediately require an investment in NWC of $55,000.You plan to market the items for three years and then sell themachine for $90,000. You expect to sell 25,000 items per year at aprice of $22. You expect variable manufacturing costs to be $20 peritem and NO fixed costs will be incurred. If the tax rate is 40%and your weighted average cost of capital is 14% per year, what isthe net present value of selling the new item? What should youdo?