​(Calculating project cash flows and​ NPV)  The Guo Chemical Corporation is considering the purchase of a chemical analysis machine.  The purchase of this machine will result in an increase in earnings before interest and taxes of ​$70,000per year. The machine has a purchase price of $250,000​,and it would cost an additional​$10,000 after tax to install this machine correctly.  In​ addition, to operate this machine​ properly, inventory must be increased by ​$15,000.This machine has an expected life of 10​years, after which time it will have no salvage value. ​ Also, assume simplified​ straight-line depreciation, that this machine is being depreciated down to​ zero, a34 percent marginal tax​ rate, and a required rate of return of15 percent. a.  What is the initial outlay associated with this​ project? b.  What are the annual​ after-tax cash flows associated with this project for years 1 through 9​? c.  What is the terminal cash flow in year 10​ (that is, the annual​ after-tax cash flow in year 10 plus any additional cash flow associated with termination of the​ project)?

Question
Asked Nov 11, 2019
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​(Calculating project cash flows and​ NPV)  
The Guo Chemical Corporation is considering the purchase of a chemical analysis machine.  The purchase of this machine will result in an increase in earnings before interest and taxes of ​$70,000per year. The machine has a purchase price of $250,000​,and it would cost an additional
​$10,000 after tax to install this machine correctly.  In​ addition, to operate this machine​ properly, inventory must be increased by ​$15,000.
This machine has an expected life of 10​years, after which time it will have no salvage value. ​ Also, assume simplified​ straight-line depreciation, that this machine is being depreciated down to​ zero, a
34 percent marginal tax​ rate, and a required rate of return of
15 percent.
 
a.  What is the initial outlay associated with this​ project?
 
b.  What are the annual​ after-tax cash flows associated with this project for years 1 through 9​?
 
c.  What is the terminal cash flow in year 10​ (that is, the annual​ after-tax cash flow in year 10 plus any additional cash flow associated with termination of the​ project)?
 
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Expert Answer

Step 1

Calculate the initial cost, annual after-tax cash flows, and terminal cash flow in year 10 as follows:

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A В D Year 1 to 9Year 10 Year 0 Particulars 2 Initial cost of machine 3 Installation charges 4 Inventory (250,000.00 (10,000.00) (15,000.00) 5 70,000.00 70,000.00 23,800.00 23,800.00 46,200.00 46,200.00 26,000.00 26,000.00 6 Earnings before interest and taxes 7 Less: Tax 34% 8 Net income 9 Add: Depreciation 10 Add: Increase in inventory 11 Operating cash flows 15,000.00 (275,000.00) 72,200.00 87,200.00

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Step 2

Workings...

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A D Year 0 Particulars Year 1 to 9 Year 10 |-250000 -10000 -15000 2 Initial cost of machine 3 Installation charges 4 Inventory 70000 -C6*34% -C6-C7 70000 =D6*34% =D6-D7 (250000+10000)10(250000+10000)10 15000 -SUM(D8 : D10) 6 Earnings before interest and taxes 7 Less: Tax@34% 8 Net income 9 Add: Depreciation 10 Add: Increase in inventory 11 Operating cash flows -SUM(B2:B10)-SUM(C8:C10) LO

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