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Net Operating Cash Flow - Acquisition of a New Machine

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?

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