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Millie's Hand Crafts is a small business

that specializes in producing hand-made decorations for Easter and selling them over the Internet. The firm opens only for a few months around the holiday time. Last year after closing the season the firm hired a designer to develop new designs hoping that it would help them to increase the sales; it costed $7,000. This year Millie's Hand Crafts was in business only in March, April, and May. In March, the firm bought all the required supplies for the production. The whole bill came up to be $60,000: half of it was paid immediately and another half - in April. All the production of decorations happened in March, while the sales occurred just before the holiday, in April. Millie's Hand Crafts produced 500 items and sold them for $150 each. 1/3 of customers paid for their purchases immediately, and the rest of customers paid only in May. The corporate tax rate is 30%.

(a) What is the firm's free cash flows in every month?

(b) If the monthly discount rate is 10%, what is the net present value of the firm's FCFs in March?


(c) Millie's Hand Crafts plans to renew its business before Christmas, in November. In an attempt to improve the manufacturing process, the firm is considering the purchase of a new embroidery machine. This machine is not expected to affect the number of manufactured items, but rather the price - each item would be sold for $160. This investment requires an outlay of $8,000 in November. IRS rules prescribe this expenditure is depreciated using straight-line depreciation over the 10 months. Millie's Hand Crafts will sell the new embroidery machine in January at its book value. If Millie's Hand Crafts decides to buy a new embroidery machine in November, it will sell its old embroidery machine. Its book value is $2,000 and it can be sold for $4,000. Suppose that the firm will buy $60,000 worth of supplies in November and will pay for them only in January. The sales will occur in December, but all the customers' bills will be paid in January.

(i) What are the depreciation tax shields in each month?

(ii) What are the firm's free cash flows without the purchase of embroidery machine and with the purchase?

(iii) If the monthly discount rate is 10%, shall Millie's Hand Crafts buy the embroidery machine? 

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