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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 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 ...

Solution Summary

The solution calculates cash outflow at time zero, years 1 through 5, and the terminal year for The Mars Company.

$2.19
See Also This Related BrainMass Solution

What is the net cost of the machine for capital budgeting purposes? What is the net operating cash flow in Year 1,2,3? What is the terminal year cash flow? If the project's cost of capital is 10%, what is the project's net present value (NPV)?

The Progresso Company is evaluating the proposed acquisition of a new milling machine. The machine's price is $100,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $45,000. The machine would require an increase in net working capital (inventory) of $10,000. The machine would have no effect on revenues, but it is expected to save the firm $50,000 per year in before-tax operating costs, mainly labor. Progresso's marginal tax rate is 40%.

What is the net cost of the machine for capital budgeting purposes? (That is, what is the Year 0 net cash flow?)
What is the net operating cash flow in Year 1?
What is the net operating cash flow in Year 2?
What is the net operating cash flow in Year 3?
What is the terminal year cash flow (year 4 when the machine is sold)?
If the project's cost of capital is 10%, what is the project's net present value (NPV)?

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