Managerial Finance
REQUIRED INVESTMENT Tannen Industries is considering an expansion. The necessary equipment would be purchased for $18 million and will be fully depreciated at the time of purchase, and the expansion would require an additional $2 million investment in net operating working capital. The tax rate is 25%.a. What is the initial investment outlay after bonus depreciation is considered?
b. The company spent and expensed $20,000 on research related to the project last year. Would this change your answer? Explain.
c. Suppose the company plans to use a building that it owns to house the project. The building could be sold for $1 million after taxes and real estate commissions. How would that fact affect your answer?REPLACEMENT ANALYSISThe Oviedo Company is considering the purchase of a new machine to replace an obsolete one.
The machine being used for the operation has a book value and a market value of zero. However, the machine is in good working order and will last at least another 10 years. The proposed replacement machine will perform the operation so much more efficiently that Oviedos engineers estimate that it will produce after-tax cash flows (labor savings) of $8,000 per year.
The after-tax cost of the new machine is $45,000, and its economic life is estimated to be 10 years. It has zero salvage value. The firm’s WACC is 10%, and its marginal tax rate is 25%. Should Oviedo buy the new machine?NEW PROJECT ANALYSISYou must evaluate a proposal to buy a new milling machine.
The purchase price of the milling machine, including shipping and installation costs, is $143,000, and the equipment will be fully depreciated at the time of purchase.
The machine would be sold after 3 years for $94,500. The machine would require a $5,000 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $52,000 per year. The marginal tax rate is 25%, and the WACC is 8%. Also, the firm spent $4,500 last year investigating the feasibility of using the machine.
a. How should the $4,500 spent last year be handled?b. What is the initial investment outlay for the machine for capital budgeting purposes after the 100% bonus depreciation is considered, that is, what is the Year 0 project cash flow?c. What are the projects annual cash flows during Years 1, 2, and 3?d. Should the machine be purchased? Explain your answer
