You must evaluate a proposal to buy a new milling machine. The base price is $135,000, and shipping and installation costs would add another $8,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $94, 500. The applicable depreciation rates are 33%, 45%, 15%, and 7% as discussed in Appendix 12A. The machine would require a $5,000 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $52,000 per year. The marginal tax rate is 35%, and the WACC is 8%. Also, the firm spent $4, 500 last year investigating the feasibility of using the machine. How should the $4, 500 spent last year be handled? What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? What are the project's annual cash flows during Years 1, 2, and 3? Should the machine be purchased? Explain your answer.
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