Dave Alvin, the CFO of Blasters Powertrain Products (BPP) has requested your assistance in evaluating a capital budgeting proposal. The proposal involves the production of a new line of gear- boxes for use in heavy freight applications. Research and development costs to develop this new line of gearboxes were $620,000 last year (2016). Production of the new product would require investment in (i.e., the purchase of) new machinery at a cost of $6.3 million, with a useful life of 4 years. BPP has conferred with its tax accountant and has been informed that they must depreciate the machinery under the MACRs 5-year class. (See page 3 for a MACRS depreciation schedule.) Forecasts indicate that the machinery can be sold for a market value of $581,640 at the end of the 4-year period.

Management expects sales to be $7.65 million in year 1, and sales are projected to increase by 2%/year over the life of the project. Variable production costs are projected to be $5.85 million in year 1 and management expects these costs to increase by 1%/year over the life of the project. Fixed production costs are expected to be $165,000 each year.

If the new line of gearboxes is produced, BPP will need to make additional investments in Net Work- ing Capital (NWC) to support the increased operations. In particular, NWC (entering any year) is ex- pected to be 10% of the projected sales for that year. That is, the NWC balance at t=0 would be 10% of the projected sales for year 1, the NWC balance at t=1 would be 10% of the projected sales for t=2, and so on. The cumulative investments in NWC made as a result of this project would be recovered in the project's final year. In other words, the NWC balance will drop to $0 at t = 4.

The discount rate (also called cost of capital) used to evaluate this project would be 10.75%, and the relevant tax rate is 35%.

Develop the incremental cash flow projections for this proposal. Please be sure to clearly identify (1) incremental operating cash flows, (2) NWC cash flows, and (3) net capital spending, and then, (4) sum these three figures to get cash flow. [Note: Normally, you would then use these cash flows to cal- culate NPV and IRR of the decision to either (1) buy the new press and sell the old one or (2) keep the old press. If NPV > 0 (and, equivalently, IRR > required return), then the firm will choose option 1. If NPV

MACRS Depreciation Percentages - Half-Year Convention PROPERTY CLASS RECOVERY YEAR 3-YEAR 5-YEAR 7-YEAR 10-YEAR 20.00% 32.00 19.20 11.52 11.52 5.76 14.29% 24.49 17.49 12.49 8.93 8.92 8.93 4.46 10.00% 18.00 14.40 11.52 9.22 7.37 6.55 6.55 6.56 6.55 3.28 33.33% 44.45 14.81 7.41 2 4 10 Totals 100.00% 100.00% 100.00% 100.00% MACRS Depreciation Percentages - Half-Year Convention PROPERTY CLASS RECOVERY YEAR 3-YEAR 5-YEAR 7-YEAR 10-YEAR 20.00% 32.00 19.20 11.52 11.52 5.76 14.29% 24.49 17.49 12.49 8.93 8.92 8.93 4.46 10.00% 18.00 14.40 11.52 9.22 7.37 6.55 6.55 6.56 6.55 3.28 33.33% 44.45 14.81 7.41 2 4 10 Totals 100.00% 100.00% 100.00% 100.00%