The BJ Company is evaluating the proposed acquisition of a new bubble gum
machine. The machine’s base price is $128,000, and it would cost another
$15,000 to modify it for special use by the firm. The machine is depreciated
at tax rates of 25 percent. It would be sold after 3 years for $70,000. The
machine would require an increase in net working capital of Inventory $10000,
Accounts Payable of $4000 and Accounts Receivable of $5000. The
machine would have no effect on revenues, but it is expected to save the firm
$45000 per year in before tax operation costs, mainly labour. Assume a tax
rate of 30 percent. The projects cost of capital is 10 percent.
Required
a) Using a table format indicate the cash flows that are relevant for
evaluating this project
Year 0 1 2 3
STEP 1 – Calculate Taxable Income
Cost savings 45,000 45,000 45,000
Depreciation -35,750 -35,750 -35,750
Gain/Loss on Sale for new machine 34,250
Taxable income 0 9,250 9,250 43,500
Tax @ 30% 0 -2,775 -2,775 -13,050
STEP 2 – Include All Cash Flows
Tax refund/paid 0 -2,775 -2,775 -13,050
Initial Cost -143,000
Cost savings 45,000 45,000 45,000
Working Capital -11,000 11,000
Salvage value of machine 70000
Net Cash Flow -154,000 42,225 42,225 112,950
PVCF @ 10% -154000 37701 33662 80396
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NPV $4144
IRR 11.28 %
PV Index 1.03
b) Should the machine be purchased? Justify your answer.
Project should be accepted
Positive NPV
IRR > 10%
PV Index > 1
Maximises shareholder wealth