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QUESTION 2 CAPITAL BUDGETING (25 POINTS)

Part a. A shoe making machine costs $80,000 today. You are considering buying this machine. The machine will depreciate by straight-line to zero over the life of 10 years. You think you can sell the machine for $40,000(sale price) at the end of year 6. Tax rate is 35%.

What is after-tax cash flow from sale of the asset machine at the end of year 6? [7.5 points]

After tax salvage value (cash-flow from asset sale) is $______________________

Part b. You expected to have net sales (revenues) of $120,000 per year. Each year, you must have Net Working Capital equal to 20% of net sales. Your year zero net working capital is zero. You will have to pay labor costs plus the variable cost of $44,000 per year at the end of each year for the next 6 years. Use depreciation information from part a. Tax rate is 35%.

What are the Free Cash Flows for years 1-6? [10 points]

year	0	1	2	3	4	5	6
Revenue
Cost
Depreciation
EBIT
Tax
Earnings
Depreciation
Net Working Capital
Change in NWC
Capital Expenditure
after-tax cash flow from sale of the asset machine Part a at year 6
FCF

Part c. What is the net present value of this project (buying this machine today and paying $80,000 and receiving the cash flows in part b) if the cost of capital of the project is 12% per year? Should you accept or reject the project? [7.5 points]

NPV of the project is $______________________

You should ACCEPT OR REJECT the project. (circle the correct decision rule)