Net Operating Cash Flow - Acquisition of a New Machine
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The Mars Company is evaluating the proposed acquisition of a new machine. The machine's base price is $600,000 plus shipping costs of $20,000. The machine falls into the MACRS 3-year class, and it would be sold after 5 years for $10,000. The machine would require an increase in net working capital of $25,000. The machine would have no effect on revenues, but it is expected to save the firm $200,000 per year for 5 years in before-tax operating costs. Mar's marginal tax rate is 35 percent and its cost of capital is 13 percent.
Questions:
a. Calculate the cash outflow at time zero.
b. Calculate the net operating cash flows for Years 1 through 5 MACRS.
c. Calculate the terminal year cash flow.
d. Should the machinery be purchased? why or why not?
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Solution Summary
The solution calculates cash outflow at time zero, years 1 through 5, and the terminal year for The Mars Company.
Solution Preview
a. Calculate the cash outflow at time zero.
The CF0 = -(machine price + shipping + increase in net working capital)
= -(600 + 20 +25) = -645 (thousand $)
The negative sign means cash outflow.
b. Calculate the net operating cash flows for Years 1 through 5 MACRS.
Each year the saving in cost will increase cash flow = saving in cost *(1-tax rate). Also the depreciation, although it is not a cash outflow, will save some tax expense.
Saving in tax = depreciation * tax rate
The MACRS 3-year class depreciation ...
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