Reference no: EM133075009

Incorporate Working Capital Into Capital Budgeting

The Olney Company purchased a machine 3 years ago at a cost of $150,000. It had an expected life of 10 years at the time of purchase and an expected salvage value of $5,000. The existing machine costs $54,000 year to run and generates $1,000,000 a year in revenue with a gross profit margin of 20%. The old machine can be sold today for $55,000 and the expectation is that it can be sold for $7,500 in 7 years.

A new machine with a 7 year life can be purchased for $225,000. Cash operating expenses will be $65,000 per year. The new machine will generate revenue of $1,100,000 per annum in the first three years of operation and then revenue of the new machine will increase to $1,200,000 per annum for the balance of machine's life. The machine has a gross profit margin of 23% due to fewer defects. At the end of its useful life, the machine will have no value. The firm's tax rate is 25 percent. Straight-line depreciation is used for all assets. The firm's WACC is 12 percent. The firm has an ACP of 63 days and pays its bills after 25 days