Question

4. Builtrite D is considering the purchase of a new machine for $500,000 which would require a $5000 installation charge. Employees would need to go through a brief training session to operate the machine properly which would cost $25,000. In addition, an increase in net working capital of $30,000 would be required. The machine has an expected life of 10 years and due to efficiencies, labor costs are expected to decrease $150,000 annually (before depreciation and taxes). Assume straight-line depreciation, a 34% marginal tax rate and a cost of capital of 15%. Should Builtrite D purchase the machine?

Answer 1

Builtrite D should purchase the machine

Explanation:

Cash outflow in year zero = $ 500,000 + $ 25,000 ( training cost ) + $ 30,000 ( Net working capital)

Cash outflow in year zero = $ 555,000

Terminal cash flow in year 10 = $ 150,000 + $ 30,000 ( NWC)

Terminal cash flow in year 10 = $ 180,000

Operating cash flow per year = [ Savings - expenses - depreciation ] X ( 1 - tax rate) + depreciation

Net present value =
`-500,000 + (116,000)/(1.15^1) + (116,000)/(1.15^2) +...+ (180,000)/(1.15^(10))`

The Net present value of purchasing the machine = $32,071.42

Builtrite D should purchase the machine