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Calculating NPV of a machine purchase proposal

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Garcia's Truckin' Inc. is considering the purchase of a new production machine for $200,000. The purchase of this machine will result in an increase in Earning before interest and taxes of $50,000 per year. To operate this machine properly, workers would have to go through a brief training session that would cost $5000 after tax. In addition, it would cost $5000 after tax to install the machine properly. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory of $20000. The machine has an expected life of 10 years, after which it has no salvage value. Finally to purchase the new machine it appears that the firm would have to borrow $100,000 at 8% interest from a local bank, resulting an interest payment of $8000 per year.Assume simplified straight line depreciation and that this machine is depreciated to zero, a 34% marginal tax rate, and a required rate of return of 10%.
a) What is the initial outlay associated with this project?
b) What are annual after tax cash flows associated with this project for years 1 through 9?
c) What is the terminal cash flow in year 10 (what is the annual after-tax flow in year 10 plus any additional cash flows associated with the termination of the project?)
d) Should this machine be purchased?
e) What is the NPV?

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Solution Summary

Solution explains the steps in finding cash flows associated with the decission. Present Value of each year's net cash flows is worked out.

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Please refer attached file for complete solution. Tables may not properly print here.

Solution:

Initial Outlay- Cash Out
Machine Cost $200,000
Installation and Training $10,000
Extra Inventory $20,000
Total $230,000

Amount in Dollars
Cash Infow Cash Out flow Net Cash PV @
At the end Depriciation EBIT Extra Total Initial Interest Income ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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