Problem:
The Johnson Company is evaluating the proposed acquisition of a new milling machine. The machine's base price is $108,000, and it would cost another $12,500 to modify it for special use. The machine falls into the MACRS 3-year class, and would be sold after 3 years for $65,000. The machine would require an increase in net working capital (inventory) of $5,500. The milling machine would have no effect on revenues, but it is expected to save the firm $44,000 per year in before tax operating costs, mainly labor. Johnson's marginal tax rate is 35%.
Q1. What is the net cost of the machine for capital budgeting purposes? (That is, what is the Year 0 net cash flow?)
Q2. What are the net operating cash flows in Years 1,2,and 3?
Q3. What is the additional (nonoperating)cash flow in Year 3?
Q4. If the project's cost of capital is 12%, should the machine be purchased?