Finance- A new piece of Equipment costs $150,000. There would be another

| January 30, 2017

Question
1) A new piece of Equipment costs $150,000. There would be another $40,000 in installation costs. Depreciation would be MACRS 3-year class with depreciation rates of 33%, 45%, 15% and 7%. The new equipment would then be sold after 3 years for $70,000. The equipment would require a $9,000 increase in NOWC (spare parts inventory). The piece of equipment would have no effect on revenue but it should save the firm $40,000 per year in before tax labor costs. The company’s marginal federal-and state tax rate is 35%.

The WACC is 12%. Should the new piece of equipment be purchased? Explain.

2) Mississippi River Shipyards is considering replacing an 8-year-old riveting machine with a new one that will increase earnings before depreciation from $27,000 to $54,000 per year. The new machine will cost $82,500 and it will have an estimated life of 8 years and no salvage value. The new machine will be depreciated over its 5-year MACRS recovery period; so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11% and 6%. The applicable corporate tax rate is 40%, and the firm’s WACC is 12%. The old machine has been fully depreciated and has no salvage value. Should the old riveting machine be replaced by the new one? Explain your answer. (Hint: use NPV)

3) ABC Corporation is considering an expansion project. To date they have spent $150,000 investigating the viability of the project and have decided to proceed. The proposed project will cost $1,500,000 in addition to the $150,000 that was spent on the feasibility study. The project will be depreciated over a 3 year MACRS class life.

MACRS

Depreciation

Year Rates

1 0.33

2 0.45

3 0.15

4 0.07

If the project is undertaken the company will need to increase its inventories by $500,000, and its accounts payable will rise by $200,000. The company will realize an additional $1,500,000 in sales over each of the next three years. The company’s operating costs (not including depreciation) will increase by $750,000 a year. The company’s tax rate is 34%. At t = 3, the project’s economic life is complete, but it will have a salvage value (before-tax) of $150,000 after three years. The project’s WACC is 12%.

a) What is the project’s net present value (NPV)? What is the IRR?

b) Write a short memo to management explaining your analysis and making a recommendation. Should the project be accepted? Why or why not? (i.e. Explain what your numerical answer means.)

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