Problem 2 (16 points)

Media Arts Components (MAC) is considering a new production machine. The new machine will cost $250,000, has a 5 year expected life and salvage value of $25,000. The new machine is expected to result in operating efficiencies which will save $40,000 annually. It will be depreciated using the MACRS method with a 5 year asset class. The machine will require new inventory of $20,000 to support the machine.

MAC is in a high risk industry and has a cost of capital of 15%. The company pays 40% of its income in taxes.

Year Cost Savings

1	$40,000
2	$45,000
3	$50,000
4	$55,000
5	$60,000

Dep. Schedule for new machine

$ 250,000 Basis

1	$50,000
2	$80,000
3	$47,500
4	$30,000
5	$27,500
6	$15,000

1. Determine the initial cash outlay if the new machine is purchased. (4 pts)

b. Determine the incremental operating cash flows in years 1-5. (5 pts)

OCF1
OCF2
OCF3
OCF4
OCF5

c. What is the terminal (non-operating) cash flow in year 5? (4 pts)

d. Should the new machine be purchased? Explain your rationale. (NPV) (3 pts)