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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

NEW PROJECT ANALYSIS 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 MACKS 3-year class, and it would be sold after 3 years for $65,000. The applicable depreciation rates are 33%, 45%, 15%, and 7% as discussed in Appendix 12A. The machine would require a $5,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $44,000 per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.

  1. a. How should the $5,000 spent last year be handled?
  2. b. What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow?
  3. c. What are the project’s annual cash flows during Years 1, 2, and 3?
  4. d. Should the machine be purchased? Explain your answer.

a.

Summary Introduction

To explain: Effect of $5,000 spent by company for investing the feasibility in the last year.

Initial Investment Outlay:

To start a business or a project, the company needs an amount, this amount is known as the initial investment outlay. It is also known as initial outlay. The amount of initial investment is calculated with the help of capital budgeting technique.

Modified Accelerated Cost Recovery System (MACRS):

It is another method of calculating the depreciation. This method involves the tax element in the calculation. By this method, the fixed asset of the company is divided into sections and then depreciation is computed.

Net Present Value (NPV):

NPV is the technique of capital budgeting. To select the project or not is dependent on the NPV of the project. If the project has positive NPV, then accept the project, if the NPV is negative, then reject the project.

Explanation

The money spent on investing the feasibility is treated as the sunk ...

b.

Summary Introduction

To compute: The initial investment outlay.

c.

Summary Introduction

To compute: The annual cash flows in first, second and third year.

d.

Summary Introduction

To explain:  Whether the machine has to be purchased.

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