El Gato’s Motors is considering the purchase of a new production machine for $1 million. The purchase of this machine will result in an increase in earnings before interest and taxes of $400,000 per year. It would cost $50,000 after tax to install this machine; in addition, to operate this machine properly, workers would have to go through a brief training session that would cost $100,000 after tax. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory of $150,000. This machine has an expected life of 10 years, after which time it will have no salvage value. Assume simplified straight-line depreciation, that this machine is being depreciated down to zero, a 34 percent marginal tax rate, and a required rate of return of 12 percent.
a. What is the initial outlay associated with this project?
b. What are the annual after-tax cash flows associated with this project for Years 1 through 9?
c. What is the terminal cash flow in Year 10 (what is the annual after-tax cash flow in Year 10 plus any additional cash flows associated with termination of the project)?
d. Should this machine be purchased?

  • CreatedOctober 31, 2014
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