J. F. Manning Metal Company is considering the purchase of a new milling machine during year 0. The machine's base price is $135,000 and it will cost another $15,000 to modify the machine for special use by the firm, resulting in a $150,000 cost base for depreciation.
The machine falls into the MACRS seven-year property class. The machine will be sold after three years for $80,000 (actual dollars).Use of the machine will require an increase in net working capital (inventory) of $10,000 at the beginning of the project year.
The machine will have no effect on revenues, but it is expected to save the firm $80,000 (today's dollars) per year in before-tax operating costs - mainly labor. The firm's marginal tax rate is 40% and this rate is expected to remain unchanged over the project's duration.
However, the company expects that the labor cost will increase at an annual rate of 5% and that the working capital requirement will grow at an annual rate of 8% caused by inflation. The selling price of the milling machine in not affected by inflation.
The general inflation rate is estimated to be 6% per year over the project period. The firm's market interest rate is 20%.
Determine the project cash flows in actual dollars.
Determine the project cash flows in constant (time-zone) dollars.
Is this project acceptable?