30 Apr WHAT IS THE PROJECTS NET PRESENT VALUE (NPV)?
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 companys 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 firms 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 companys operating costs (not including depreciation) will increase by $750,000 a year. The companys tax rate is 34%. At t = 3, the projects economic life is complete, but it will have a salvage value (before-tax) of $150,000 after three years. The projects WACC is 12%.
a) What is the projects 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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