FIN5FMA Tutorial 4 solutions.docx - FINANCIAL MANAGEMENT...

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FINANCIAL MANAGEMENT (FIN5FMA)SOLUTIONS FOR TUTORIAL 4Question 1You 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. Themachine 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% asdiscussed in Appendix 12A. The machine would require a $5,500 increase inworking capital (increased inventory less increased accounts payable). Therewould be no effect on revenues, but pre-tax labor costs would decline by $44,000per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firmspent $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, theYear 0 project cash flow?
c) What are the project’s annual net cash flows during Years 1, 2 and 3?
d) Should the machine be purchased? Explain your answer.
Salvage value$65,000Tax on gain from disposal-$19,798Recovery of NWC (assumed)$5,500$50,702Notes:1)Book value of machine at the end of year 3 = $120,500(0.07) = $8,4352)Tax on gain from disposal = ($65,000 - $8,435)(0.35) = $19,7983)Note that it does not specifically mention in the question that the net workingcapital investment made at the start of the project will be recovered at the end.

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Term
Three
Professor
DUSA

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