Klepto Hardware Store is run by a sole trader,Kee Lee,whose personal marginal tax rate is 40%.Kee is considering the purchase of a new key-cutting machine that costs $30,000. As the new machine will cut a larger range of keys than Kees old machine he will need to carry a larger number of blank keys on hand, requiring a total of approximately $1,000 worth of blanks. Over its 10 year estimated life, the new machine will generate extra sales of about $4,000 per year, as well as labour-cost, wastage and defective keys savings of $3,000 p.a.

The old key-cutting machine (which will be replaced by the new machine) was purchased 5 years ago for $20,000 and also has a 10-year expected life. Kee has been depreciating the old machine at 10% p.a. (straight-line basis, down to an expected salvage value of zero). His cousin (who runs a hardware store in a country town) has told Kee that he would pay $8,000 to buy the old machine if Kee wants to replace it now. During the period for which Kee has been using the old machine he has carried an average amount of $700 worth of blank keys.

Kee has just returned from a $400 trip to Melbourne to have a demonstration of the new machine, which he believes he had to spend to make an informed decision about the purchase of the new machine.

(i) Detail the initial outlay amount that should be included in a capital budgeting evaluation to purchase the new key-cutting machine. (6 marks)

(ii) Briefly explain how do sunk costs affect the determination of cash flows associated with an investment proposal?