You must evaluate a proposal to buy a new milling machine. Thepurchase price of the milling machine, including shipping andinstallation costs, is $128,000, and the equipment will be fullydepreciated at the time of purchase. The machine would be soldafter 3 years for $62,000. The machine would require a $10,000increase in net operating working capital (increased inventory lessincreased accounts payable). There would be no effect on revenues,but pretax labor costs would decline by $38,000 per year. Themarginal tax rate is 25%, and the WACC is 9%. Also, the firm spent$4,500 last year investigating the feasibility of using themachine.

1. How should the $4,500 spent last year be handled?
   1. Last year's expenditure is considered a sunk cost and does notrepresent an incremental cash flow. Hence, it should not beincluded in the analysis.
   2. The cost of research is an incremental cash flow and should beincluded in the analysis.
   3. Only the tax effect of the research expenses should be includedin the analysis.
   4. 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.
   5. Last year's expenditure is considered an opportunity cost anddoes not represent an incremental cash flow. Hence, it should notbe included in the analysis.
   
   -Select-IIIIIIIVVItem 1
   
2. What is the initial investment outlay for the machine forcapital budgeting purposes after the 100% bonus depreciation isconsidered, that is, what is the Year 0 project cash flow? Enteryour answer as a positive value. Round your answer to the nearestdollar.
   $  
   
3. What are the project's annual cash flows during Years 1, 2, and3? Do not round intermediate calculations. Round your answers tothe nearest dollar.
   Year 1: $  
   Year 2: $  
   Year 3: $  
   
4. Should the machine be purchased?