You have been asked by the president and CEO of Kidd Pharmaceuticals to evaluate the proposed
acquisition of a new labeling machine for one of the firm's production lines. The machine's price is
$50,000, and it would cost another $10,000 for transportation and installation. The machine falls into
the MACRS three-year class, and hence the tax depreciation allowances are 0.33, 0.45, and 0.15 in
Years 1, 2, and 3, respectively. The machine would be sold after three years because the production
line is being closed at that time. The best estimate of the machine's salvage value after three years of
use is $20,000. The machine would have no effect on the firm's sales or revenues, but it is expected to
save Kidd $20,000 per year in before-tax operating costs. The firm's tax rate is 30 percent and its
corporate cost of capital is 10 percent.
a. What is the project's net investment outlay at Year 0?
b. What are the project's operating cash flows in Years 1, 2, and 3?
c. What are the terminal cash flows at the end of Year 3?
d. If the project has average risk, is it expected to be profitable?