(ST–1)

New-Project Analysis You have been asked by the president of the Farr Construction Company to evaluate the proposed acquisition of a new earth mover. The mover’s basic price is

$50,000, and it would cost another $10,000 to modify it for special use. Assume that the mover falls into the MACRS 3-year class (see Appendix 11A), that it would be sold after 3 years for $20,000, and that it would require an increase in net working capital (spare parts inventory) of $2,000. The earth mover would have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm’s marginal federal-plus-state tax rate is 40%.

a. What are the Year-0 cash flows?

b. What are the operating cash flows in Years 1, 2, and 3?

c. What are the additional (nonoperating) cash flows in Year 3?

d. If the project’s cost of capital is 10%, should the earth mover be purchased?

Chapter 11: Cash Flow Estimation and Risk Analysis 457