Capital Budgeting Cash Flows
Gizmo Corporation expects rapidly increasing demand for gizmos, and is considering
expansion of its production facility.
The project would require the firm to purchase new
equipment and upgrade old software.
The cost of the new equipment is $1,250,000.
Delivery would cost $50,000 and installation would amount to $30,000.
would have a class life of 7 years, but the firm is planning to keep the equipment for 5 years.
Gizmo executives expect to be able to sell the equipment for $200,000 at the end of the fifth
A one-time working capital investment of $40,000 would be required at the time of
The firm would also be required to train employees to use the new equipment.
The training program would cost $5,000.
Gizmo Corporation uses simplified straight line depreciation, has a marginal cost of capital
of 11 percent, and has a marginal tax rate of 34 percent.
Since the capital investment
represents expansion of the firm's current line of business, the risk of the project is equivalent
to the overall risk of the firm.
Following are current annual sales and expense figures, and forecasts of annual sales and
expense numbers if the capital investment project is undertaken.
With new equipment
Cash operating expenses
Cost of defects
Should the firm invest in this expansion project?