Cash Flow Estimation with Opportunity Costs and Cannibalization

Your company is considering the purchase of a new piece of machinery to produce a new

product. The machine has a four$-$year economic life and a purchase price of $$100,000.$

Additional charges of $$10,000$ for delivery, $$2,500$ for installation, and $$1,000$ for testing of

the machine will also be incurred before the project can begin. The machine falls under the $3-$

year MACRS class. The depreciation rates for years one through four are $33\%,45\%,15\%,$

$7\%,$ respectively. The machine will be sold at the end of the fourth year for an estimated

$$20,000.$ Purchasing the machine will cause inventories to increase by $$10,000$ and accounts

payables to increase by $$3,000$ and these amounts will remain each year of the project. The

machine will produce incremental gross sales of $$150,000$ in each of the four years, but also

incur additional operating costs of $$20,000$ each year. The new project would lower pre$-$tax

sales of the firm's other products by $$15,000$ each year, but it would also allow an annual

$$7,000$ reduction in costs for the other products, due to decreases in volume. If the firm

proceeds with this project it will be giving up $$5,000$ annual rent that it now receives from

renting out the space where the machine will be used. The firm's marginal tax rate is $40\%.$