You must evaluate a proposal to buy a new milling machine. The base price is $108,000, and shipping and installation costs would add another $12,500. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $65,000. The applicable depreciation rates are 33, 45, 15, and 7%. The machine would require a $5,500 increase in working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pre-tax labor costs would decline by $44,000 per year. The marginal tax rate is 35 percent, and the WACC is 12 percent. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.
a. How should the $5,000 spent last year be handled?
b. What is the net cost of the machine for capital budgeting purposes, that is, the Year 0 project cash flow?
c. What are the net operating cash flows during Years 1, 2, and 3?
d. What is the terminal year cash flow?
e. Should the machine be purchased?
This solution analyzes if a machine should be purchased based on cash flow estimates, depreciation and previous spending. Calculations are attached in Excel.