Wilson Machine Tools, Inc., a manufacturer of fabricated metal products, is considering the purchase of a high-tech computer-controlled milling machine at a cost of $95,000. The cost of installing the machine, preparing the site, wiring, and rearranging other equipment is expected to be $15,000. This installation cost will be added to the cost of the machine in order to determine the total cost basis for depreciation. Special jigs and tool die for a particular product will also be required at a cost of $10,000. The milling machine is expected to last 10 years, but the jigs and dies for only five years. Therefore, another set of jigs and dies has to be purchased at the end of five years. The milling machine will have a $10,000 salvage value at the end of its life, and the special jigs and dies are worth only$300 as scrap metal at any time in their lives. The machine is classified as a seven-year MACRS property, and the special jigs and dies are classified as a three-year MACRS property. With the new milling machine, Wilson expects additional annual revenue of $80,000 from increased production. The additional annual production costs are estimated as follows: materials, $9,000; labor, $15,000; energy, $4,500; and miscellaneous O&M costs, $3,000. Wilson's marginal income-tax rate is expected to remain at 35% over the project life of 10 years.All dollar figures are in today's dollars. The firm's market interest rate is 18%, and the expected general inflation rate during the project period is estimated at 6%.(a) Determine the project cash flows in the absence of inflation.(b) Determine the internal rate of return for the project based on your answer to part (a).(c) Suppose that Wilson expects the following price increases during the project period: materials at 4% per year, labor at 5% per year, and energy and other O&M costs at 3% per year. To compensate for these increases in prices, Wilson is planning to increase annual revenue at the rate of 7% per year by charging its customers a higher price. No changes in salvage value are expected for the machine, the jigs, and the dies. Determine the project cash flows in actual dollars.( d) From your answer to part ( c ), determine the real (inflation-free) rate ofreturn of the project.(e) Determine the economic loss (or gain) in present worth caused by inflation.
Depreciation Methods
The word "depreciation" is defined as an accounting method wherein the cost of tangible assets is spread over its useful life and it usually denotes how much of the assets value has been used up. The depreciation is usually considered as an operating expense. The main reason behind depreciation includes wear and tear of the assets, obsolescence etc.
Depreciation Accounting
In terms of accounting, with the passage of time the value of a fixed asset (like machinery, plants, furniture etc.) goes down over a specific period of time is known as depreciation. Now, the question comes in your mind, why the value of the fixed asset reduces over time.
Wilson Machine Tools, Inc., a manufacturer of fabricated metal products, is considering the purchase of a high-tech computer-controlled milling machine at a cost of $95,000. The cost of installing the machine, preparing the site, wiring, and rearranging other equipment is expected to be $15,000. This installation cost will be added to the cost of the machine in order to determine the total cost basis for depreciation. Special jigs and tool die for a particular product will also be required at a cost of $10,000. The milling machine is expected to last 10 years, but the jigs and dies for only five years. Therefore, another set of jigs and dies has to be purchased at the end of five years. The milling machine will have a $10,000 salvage value at the end of its life, and the special jigs and dies are worth only
$300 as scrap metal at any time in their lives. The machine is classified as a seven-year MACRS property, and the special jigs and dies are classified as a three-year MACRS property. With the new milling machine, Wilson expects additional annual revenue of $80,000 from increased production. The additional annual production costs are estimated as follows: materials, $9,000; labor, $15,000; energy, $4,500; and miscellaneous O&M costs, $3,000. Wilson's marginal income-tax rate is expected to remain at 35% over the project life of 10 years.All dollar figures are in today's dollars. The firm's market interest rate is 18%, and the expected general inflation rate during the project period is estimated at 6%.
(a) Determine the project cash flows in the absence of inflation.
(b) Determine the
(c) Suppose that Wilson expects the following price increases during the project period: materials at 4% per year, labor at 5% per year, and energy and other O&M costs at 3% per year. To compensate for these increases in prices, Wilson is planning to increase annual revenue at the rate of 7% per year by charging its customers a higher price. No changes in salvage value are expected for the machine, the jigs, and the dies. Determine the project cash flows in actual dollars.
( d) From your answer to part ( c ), determine the real (inflation-free) rate of
return of the project.
(e) Determine the economic loss (or gain) in present worth caused by inflation.
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