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You have been asked to evaluate the proposed acquisition of a new machine. The machine's price...

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Finance

You have been asked to evaluate the proposed acquisition of anew machine. The machine's price is $1,000,000 and our accountantrequires that it be written off over its 5-year class usingstraight-line depreciation to a book value of $0 even though weintend to keep it for only 3 years. Purchase of the machine wouldrequire an increase in net working capital of $20,000 at t=0 only.The machine would increase the firms before-tax revenues by$100,000 per year as well. It is expected to be used for 3 yearsand then be sold for $800,000. The firm's marginal tax rate is 40percent, and the project's cost of capital is 18 percent.

A. What is the net investment required at t=0?

B. What are the operating cash flows each year?

C. What is the total value of the ending (non-operating) cashflow in year 3?

D. what is the projects NPV?

Answer & Explanation Solved by verified expert
3.8 Ratings (576 Votes)

Time line 0 1 2 3
Cost of new machine -1000000
Initial working capital -20000
=a. Initial Investment outlay -1020000
100.00%
Profits 100000 100000 100000
-Depreciation Cost of equipment/no. of years -200000 -200000 -200000 400000 =Salvage Value
=Pretax cash flows -100000 -100000 -100000
-taxes =(Pretax cash flows)*(1-tax) -60000 -60000 -60000
+Depreciation 200000 200000 200000
=b. after tax operating cash flow 140000 140000 140000
reversal of working capital 20000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 480000
+Tax shield on salvage book value =Salvage value * tax rate 160000
=c. Terminal year after tax cash flows 660000
Total Cash flow for the period -1020000 140000 140000 800000
Discount factor= (1+discount rate)^corresponding period 1 1.18 1.3924 1.643032
Discounted CF= Cashflow/discount factor -1020000 118644.0678 100545.82 486904.7
d. NPV= Sum of discounted CF= -313905.4139

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Transcribed Image Text

You have been asked to evaluate the proposed acquisition of anew machine. The machine's price is $1,000,000 and our accountantrequires that it be written off over its 5-year class usingstraight-line depreciation to a book value of $0 even though weintend to keep it for only 3 years. Purchase of the machine wouldrequire an increase in net working capital of $20,000 at t=0 only.The machine would increase the firms before-tax revenues by$100,000 per year as well. It is expected to be used for 3 yearsand then be sold for $800,000. The firm's marginal tax rate is 40percent, and the project's cost of capital is 18 percent.A. What is the net investment required at t=0?B. What are the operating cash flows each year?C. What is the total value of the ending (non-operating) cashflow in year 3?D. what is the projects NPV?

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