Question
1a. The Fast Feet Shoe Company is contemplating the replacement of one of its material handling machines with a newer and more efficient one. The
1a. The Fast Feet Shoe Company is contemplating the replacement of one of its material handling machines with a newer and more efficient one. The old machine was purchased three years ago for $700,000 and is being depreciated under the 5-year MACRS class (20%, 32%, 19.2%, 11.52%, 11.52%, 5.76%). The machine has a useful life to the firm of five more years and management believes that the machine could be scrapped for $40,000 five years from now. The old machine can be sold now, however, for $150,000. The new machine has a purchase price of $1.2 million, an estimated useful life and MACRS class life of five years, and an estimated salvage value at the end of the five years of $75,000. An engineering consultant estimates that the new machine will economize on electric power usage, labor, and repair costs, and to reduce the number of damaged products. However, the change in the operating process will require an additional investment of $50,000 in working capital at implementation. The working capital investment is fully recoverable at the end of the project life. In total, the engineering study, which cost $80,000, estimates an annual savings of $275,000 per year will be realized if the new machine is installed. The company is in the 40-percent federal-plus-state tax bracket, and 11 percent is the appropriate cost of capital for this project. Should the company accept the project? Justify your answer with an NPV and IRR.
1b. Current tax code calls for a 26% tax rate (approx. 21% federal and typical 5% state) and allows capital equipment to be expensed immediately as opposed to be depreciated by MACRS (begins to phase out in 2023). Re-do the analysis in 1a but expense the capital equipment immediately (assume time 0 since firms pay taxes quarterly) and with a tax rate of 26%. Should the company accept the project? Justify your answer with an NPV and IRR.
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