Question 2 (20 marks)

You must evaluate a proposal to buy a new milling machine with purchase price of $150,000. The machine will be depreciated to zero value over the 4 years using prime cost (straight line) method. The machine would be sold after 4 years for $70,000.

Inventory will increase by $17,000 and account payables will rise by $7,500. All other working capital components will stay the same, so the change in net working capital is $9,500. The managers expect to fully recover the working capital of $9,500 at the end of the project (year 4).

The pretax labor costs would decline by $50,000 per year.

Below shows the forecasted sales revenues, variable cost and fixed cost.

	Year 1	Year 2	Year 3	Year 4
Sales quantity (units)	2,500	3,000	3,500	4,000
Selling price per unit	$3	$3.1	$3.2	$3.3
Fixed cost of production (per year)	$2,000	$2,100	$2,200	$2,300
Variable cost of production (per unit)	$1.1	$1.2	$1.25	$1.35

The marginal tax rate is 35% and the discount rate is 10.5%.

1. What is the net present value (NPV) of the proposal? (18 marks)

2. Advise should the project be accepted based on your answer in part (i)? (2 marks)