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Unformatted text preview: BADM 115 – Section 11 Prof. Isabelle Bajeux‐Besnainou Fall 2008 Form B QUIZ #8 You must evaluate a proposal to buy a new milling machine. The base price is $82,000, and shipping and installation costs would add another $4,500. The machine falls into the MACRS 3‐year class, and it would be sold after 3 years for $31,000. The applicable depreciation rates are listed in Table 1. The machine would require a $7,200 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 $35,600 per year. The marginal tax rate is 30 percent, and the WACC is 11 percent. Also, the firm spent $3,400 last year investigating the feasibility of using the machine. Table 1 Ownership Year 1 2 3 4 5 6 7 8 9 10 11 3‐Year 33% 45% 15% 7% 100% Recovery Allowance Percentage for Personal Property CLASS OF INVESTMENT 5‐Year 7‐Year 20% 14% 32% 25% 19% 17% 12% 13% 11% 9% 6% 9% 9% 4% 100% 100% 10‐Year 10% 18% 14% 12% 9% 7% 7% 7% 7% 6% 3% 100% a. (3 points) What are the net operating cash flows during Years 1, 2, and 3? The operating cash flows follow: Year 1 Year 2 Year 3 1. After‐tax savings $24,920 $24,920 $24,920 2. Depreciation tax savings $ 8,564 $11,678 $ 3.893 Net cash flow $33,484 $36,598 $28,813 Notes: 1. The after‐tax cost savings is $35,600(1 – T) = $35,600(0.7) = $24,920. 2. The depreciation expense in each year is the depreciable basis, $86,500, times the MACRS allowance percentages of 0.33, 0.45, and 0.15 for Years 1, 2, and 3, respectively. Depreciation expense in Years 1, 2, and 3 is $28,545, $38,925, and $12,975. The depreciation tax savings is calculated as the tax rate (30%) times the depreciation expense in each year. B ‐ 1 b. (2 points) What is the terminal year cash flow? The terminal cash flow is $30,717: Salvage value $31,000 Tax on SV* (7,484) Return of NOWC 7,200 $30,717 *Tax on SV = ($31,000 – $6,055)(0.3) = $7,484. BV in Year 4 = $86,500(0.07) = $6,055. c. (1 point) How should the $3,400 spent last year be handled? The $3,400 spent last year on exploring the feasibility of the project is a sunk cost and should not be included in the analysis. d. (2 points) What is the net cost of the machine for capital budgeting purposes, that is, the Year 0 project cash flow? The net cost is $93,700: Price ($82,000) Modification (4,500) Increase in NOWC (7,200) Cash outlay for new machine ($93,700) e. (2 points) Should the machine be purchased? Explain your answer. The project has an NPV of $8,556; thus, it should be accepted. Year Net Cash Flow PV @ 11% 0 ($93,700) ($93,700) 1 33,484 30,166 2 36,598 29,704 3 59,530 43,527 $9,697 Alternatively, place the cash flows on a time line: 0 1 2 3     ‐93,700 33,484 36,598 28,813 30,717 59,530 With a financial calculator, input the appropriate cash flows into the cash flow register, input I/YR = 11, and then solve for NPV = $9,697. B ‐ 2 ...
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This note was uploaded on 01/02/2010 for the course BADM 115 taught by Professor Bajeux during the Fall '08 term at GWU.
 Fall '08
 Bajeux
 Management

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