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1 2 3 Your firm has a weighted average cost of capital (WACC) of 10 percent, a 26 percent tax rate and is considering a machine that has an initial cost of $140,000, but additional modifications must be made at a cost of $30,000. The machine has a 3-year economic life and will save the firm $60,000 per year. It the machine is purchase net operating working capital (NOWC) will increase by $8,000, but may be totally recovered at the project's termination. The machine will be depreciated using the MACR 3-year class life with half-year convention. Thus, there will be a remaining adjusted basis in year 3 when the project is terminated and the machine is sold for $60,000. Terminal Cash Flows must include the taxes on the sale of the machine in year 3. The Initial Cash Flows, Operating Cash Flows and Terminal Cash Flows are given. Determine the NPV for the project (the cash flows are already determined for you) and the IRR for the project. Depreciation Schedule:3-year class life, assuming half year convention Initial Basis 170,000 Year Dep Rate Depreciation Adj Basis 0.33 56,100 113,900 0.45 76,500 37,400 0.15 25,500 11,900 0.07 11,900 Initial Cash Flows at t = 0: CAPEX is total initial canital cost and "NOWC is the net increase in working capital Price -S140,000 Modification --30.000 CAPEX -$170,000 NOWC Initial investment outlay -S178.000 Machine's operating cash flows: Year CEBT Depreciation Taxable income Taxes CEAT 60,000 56,100 58,986 60,000 76,500 -16,500 0 60,000 60,000 25,500 34,500 3,600* 56,400 *Operating losses may be carried forward, thus taxes in year 3 are: (534,500-$16,500)*0.26=53,600 *0.26 Machine's Terminal cash flows at = 3: Salvage value Tax on salwage value Recovery of NOWC CEAT $60,000 12,506** 8,000 55,494 **Tax on Salvage =(Salvage value-Adjusted Basis)0.26=($60,000 - $11,900)0.26= $12,506 0 -8.000 3,900 1014 1 2 3 NPV= IRR= Should your firm purchase or reject the new machine