Wilson Machine Tools, Inc., a manufacturer of fabricated metal products, is considering purchasing a high-tech computer-controlled milling machine at a cost of $95,000. The cost of installing the machine, preparing the site, wiring, and rear ranging other equipment is expected to be $15,000. This installation cost will be added to the cost of the machine to determine the total cost basis for depreciation. Special jigs and tool dies for the particular product also will be required at a cost >: $10,000. The milling machine is expected to las) 10 years, the jigs and dies only five years. Therefore, another set of jigs and dies has to be purchased at the end of five years. The milling machine will have a $10,000 salvage value at the end of its life, and the special jigs and dies are worth only $300 as scrap metal at any time in their lives. The machine is classified as a seven-year MACRS property, and the special jigs and dies are classified as a three-year MACRS property. With the new milling machine, Wilson expects an additional annual revenue of $80,000 due to increased production. The additional annual production costs are estimated as follows: materials, $9,000; labor, $15,000; energy, $4,500; and miscellaneous O&M costs, $3,000. Wilson's marginal income-tax rate is expected to remain at 35% over the project life of 10 years. All dollar figures represent today's dollars. The firm's market interest rate is 18%, and the expected general inflation rate during the project period is estimated at 6%.
(a) Determine the project cash flows in the absence of inflation.
(b) Determine the internal rate of return for the project in part (a).
(c) Suppose that Wilson expects price increases during the project period: material at 4% per year, labor at 5% per year, and energy and other O&M costs at 3% per year. To compensate for these increases in prices, Wilson is planning to increase annual revenue at the rate of 7% per year by charging its customers a higher price. No changes in salvage value are expected for the machine or the jigs and dies. Determine the project cash flows in actual dollars.
(d) In part (c), determine the real (inflation-free) rate of return of the project.
(e) Determine the economic loss (or gain) in present worth caused by inflation.