Reed Incorporated is considering a proposal to acquire new equipment for its manufacturing division. The equipment will
Question:
Reed Incorporated is considering a proposal to acquire new equipment for its manufacturing division. The equipment will cost \($192,000,\) be useful for four years, and have a \($12,000\) salvage value. Reed expects annual savings in cash operating expenses (before taxes) of \($68,000.\) For tax purposes, the annual depreciation deduction will be \($64,000,\) \($86,000,\) \($28,000,\) and \($14,000,\) respectively, for the four years (the salvage value is ignored on the tax return). The income tax rate is 40%. Reed establishes a hurdle rate for a net present value analysis at the company's weighted average cost of capital plus 1 percentage point. Reed's capital is provided in the following proportions: debt, 50%; common stock, 35%; and retained earnings, 15%. The cost rates for these capital sources are debt, 8%; common stock, 10%; and retained earnings, 12%. Required
a. Compute Reed's (1) weighted average cost of capital and (2) hurdle rate.
b. Using Reed's hurdle rate, compute the net present value of this capital expenditure proposal. Under net present value analysis, should Reed accept the proposal? (Round amounts to the nearest dollar.)
Step by Step Answer:
Managerial Accounting For Undergraduates
ISBN: 9780357499948
2nd Edition
Authors: James Wallace, Scott Hobson, Theodore Christensen