J. F. Manning Metal Company is considering the purchase of a new millingmachine 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 is not affected by inflation. The general inflation rate is estimated to be6% per year over the project period. The firm's market interest rate is 20%.(a) Determine the project cash flows in actual dollars.(b) Determine the project cash flows in constant (time-zero) dollars.(c) Is this project acceptable?
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 is 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%.
(a) Determine the project cash flows in actual dollars.
(b) Determine the project cash flows in constant (time-zero) dollars.
(c) Is this project acceptable?
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