You must evaluate a proposal to buy a new milling machine. Thebase price is $124,000, and shipping and installation costs wouldadd another $15,000. The machine falls into the MACRS 3-year class,and it would be sold after 3 years for $55,800. The applicabledepreciation rates are 33%, 45%, 15%, and 7%. The machine wouldrequire a $3,000 increase in net operating working capital(increased inventory less increased accounts payable). There wouldbe no effect on revenues, but pretax labor costs would decline by$59,000 per year. The marginal tax rate is 35%, and the WACC is10%. Also, the firm spent $5,000 last year investigating thefeasibility of using the machine.

a.)How should the $5,000 spent last year be handled?

1. The cost of research is anincremental cash flow and should be included in the analysis.
2. Only the tax effect of theresearch expenses should be included in the analysis.
3. Last year's expenditureshould be treated as a terminal cash flow and dealt with at the endof the project's life. Hence, it should not be included in theinitial investment outlay.
4. Last year's expenditure isconsidered as an opportunity cost and does not represent anincremental cash flow. Hence, it should not be included in theanalysis.
5. Last year's expenditure isconsidered as a sunk cost and does not represent an incrementalcash flow. Hence, it should not 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.

d.)Should the machine be purchased? Yes or No?