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(15 points) Your corporation is thinking to automate its production. The automation system is going to cost $500, 000. It will be used in a
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(15 points) Your corporation is thinking to automate its production. The automation system is going to cost $500, 000. It will be used in a 5-year project, but its depreciation schedule is over three years. In particular, depreciation allowance is 50% in year 1, 30% in year 2 and 20% in year 3. You expect the market value to be $20, 000 at the end of year 5. The required initial increase in working capital (in year 1) is $40,000. Suppose that tax rate is 20%, and the required cost of capital is 15%.
(a) (8 points) Suppose that the automation project is going to increase sales by $5,000 per year and also reduce costs. What level of annual pretax cost savings should the automation project generate in order to be financially attractive? (b) (7 points) What if depreciation schedule is linear (that is, every year depreciation amount is $100,000)? Briefly comment why pretax cost saving is higher or lower than in part (a).
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