Due to high demand for wood, San Lorenzo Lumber is considering buying a new timber cutting machine to add to its existing stock.

• The machine will cost $340,000 to purchase and $20,000 for shipping and installation. Last year, the firm cleared an unused area in its timber mill to make space for the machine, at a cost of $8,000.
• The new cutting machine will allow the company to sell an additional 140,000 pieces of wood per year, at a price of $5 per piece. Variable costs, including timber, electricity and labor, are expected to add up to 70% of sales.
• To make best use of the new machine, the company will need to increase its inventory of timber logs by $25,000. Since the firm uses trade credit when purchasing raw timber, accounts payable will increase by $12,000.
• The cutting machine is expected to last 4 years and will then be sold for $35,000. It falls into the 3-year MACRS class, with depreciation rates as follows:

Year	1	2	3	4
Depreciation rate	33%	45%	15%	7%

The firm has a marginal tax rate (federal and state) of 34%.

Part 1

What is the initial (year-0) project cash flow? Choose the right sign.

Correct

At the beginning of the project, EBIT and depreciation are both zero.

Initial capital expenditure is the cost of purchase and installation: CAPEX₀ = 340,000 + 20,000 = 360,000 This is the amount that can be depreciated over time. The cost of clearing the space for the machine is a sunk cost and should not be considered anymore.

The required inventory of wood creates a positive change in net operating working capital, while the increase in accounts payable decreases net operating working capital: NOWC = Inventory - Accounts payable = 25,000 - 12,000 = 13,000

PCF₀ = NOPAT + DEP - CAPEX - NOWC = EBIT (1-t) + Dep. - CAPEX - NOWC = 0 + 0 - 360,000 - 13,000 = -373,000

Part 2

What is the project cash flow in year 1?

Correct

In year 1, capital expenditure and the change in net operating working capital are zero.

Dep₁ = 0.33 * 360,000 = 118,800

EBIT = Revenue - Costs - Depreciation = P * Q - 0.7 P * Q - Depreciation = 5 * 140,000 - 0.7 * 5 * 140,000 - 118,800 = 91,200

PCF₁ = NOPAT + DEP - CAPEX - NOWC = EBIT (1-t) + Dep. - CAPEX - NOWC = 91,200 (1-0.34) + 118,800 - 0 - 0 = 178,992

Part 3

What is the project cash flow in year 2?

Correct

In year 2, capital expenditure and the change in net operating working capital are still zero.

Dep₂ = 0.45 * 360,000 = 162,000

EBIT = Revenue - Costs - Depreciation = P * Q - 0.7 P * Q - Depreciation = 5 * 140,000 - 0.7 * 5 * 140,000 - 162,000 = 48,000

PCF₂ = NOPAT + DEP - CAPEX - NOWC = EBIT (1-t) + Dep. - CAPEX - NOWC = 48,000 (1-0.34) + 162,000 - 0 - 0 = 193,680

Part 4

What is the project cash flow in year 3? (Need help)