A Project Requiring Multiple Assets
Langley Manufacturing Company (LMC), a manufacturer of fabricated metal products, is considering purchasing a new computer-controlled milling machine to produce a custom-ordered metal product. The following summarizes the relevant financial data related to the project.
- The machine costs $90,000. The costs for its installation, site preparation, and wiring are expected to be $10,000. The machine also needs special jigs and dies, which will cost $12,000. The milling machine is expected to last ten years, the jigs and dies five years. The machine will have a $10,000 salvage value at the end of its life. The special jigs and dies are worth only $1,000 as scrap metal at any time in their lives. The milling machine is classified as a seven-year MACRS property and the jigs and dies as a three-year MACRS property.
- LMC needs to either purchase or build an 8,000- ft^{2} warehouse in which to store the product before it is shipped to the customer. LMC has decided to purchase a building near the plant at a cost of $160,000. For depreciation purposes, the warehouse cost of $160,000 is divided into $120,000 for the building (39-year real property) and $40,000 for land. At the end of ten years, the building will have a salvage value of $80,000, but the value of the land will have appreciated to $110,000.
- The revenue from increased production is expected to be $150,000 per year. The additional annual production costs are estimated as follows: materials, $22,000; labor, $32,000; energy $3,500; and other miscellaneous costs, $2,500.
- For the analysis, a ten-year life will be used. LMC has a marginal tax rate of 40% and a MARR of 18%. No money is borrowed to finance the project. Capital gains also will be taxed at 40\%.^{7}
Discussion: Three types of assets are to be considered in this problem: the milling machine, the jigs and dies, and the warehouse. The first two assets are personal properties and the last is a real property. The cost basis for each asset has to be determined separately. For the milling machine, we need to add the site-preparation expense to the cost basis, whereas we need to subtract the land cost from the warehouse cost to establish the correct cost basis for the real property. The various cost bases are:
• The milling machine: $90,000 + $10,000 = $100,000
• Jigs and dies: $12,000
• Warehouse (building): $120,000
• Warehouse (land): $40,000
Since the jigs and dies last only five years, we need to make a specific assumption regarding the replacement cost at the end of that time. In this problem, we will assume that the replacement cost would be approximately equal to the cost of the initial purchase. We will also assume that the warehouse property will be placed in service in January, which indicates that the first year’s depreciation percentage will be 2.4573%. (See Table 10.9.)
Table 10.9 Generalized Cash Flow Approach in Tabular Format
| End of Period | ||||
| Cash Flow Elements | 0 | 1 | 2 | . . . N |
| Investment activities: | ||||
| -I_{n} | ||||
| +S_{n}- G_{n} | ||||
| -W_{n} | ||||
| Operating activities: | ||||
| + \left(1+t_{m}\right)\left(R_{n}\right) | ||||
| - \left(1+t_{m}\right)\left(E_{n}\right) | ||||
| - \left(1+t_{m}\right)\left(IP_{n}\right) | ||||
| +t_{m} D_{m} | ||||
| Financing activities: | ||||
| +B_{n} | ||||
| -PP_{n} | ||||
| Net cash flow: | ||||
| A_{n} | ||||
