2009: ABC company wants to invest in a new machine which would increase their sale. The proposal is to start a new product with this machine. The purchase price of this machine is $750,000 and installation costs would total $60,000. Machines useful life is 5 years and, for tax purposes, depreciation charges would be according to the 7-year-asset MACRS schedule. The machinery cost and the installation costs should be capitalized at t=0 and fully depreciated using the MACRS schedule.

Interest charges associated with this investment's financing have been estimated at approximately $70,000 per year, for each year of the project's estimated useful life.

Management expects the machinery to be sold for a scrap value of $117,000 at the end of year 5.

Ronny Gupta, accountant, pointed out that the portion of the factory that would house this new

equipment machinery underwent a major 'renovation' 15 months ago with a total cost of $105,200. Because

the project would not have been feasible without the renovation, Ronny suggests that the costs of the renovation

should be allocated to the project as one of its initial expenses.

The incremental sales (revenues) projections for this investment are shown near the end of this problem

statement. Variable operating costs, excluding depreciation, are projected to be 40% of same-year sales. Incremental fixed costs (for maintenance, etc.) are projected to be $25,000 in the first year. For each of the remaining years of operation, this fixed-cost component is projected to increase by 2% per year.

If the new machinery is purchased, some of ABC's Net Working Capital accounts will be affected.

The schedule near the end of the problem statement shows balances for Accounts Receivable, Inventory, and

Accounts Payable across the project's life. Of course, you'll need to use this information to build the NWC

Tracker, which in turn feeds into the Net Working Capital term in the cash-flow worksheet.

The VP of ABC company, Eugene Ricardo, requests your assistance in preparing an analysis

of the net cash flow projections for the proposed investment. He believes that the systematic risk of

this project is similar to the average systematic risk of other ABC's projects. Eugene also indicates that 30%

is the appropriate tax rate for this entire analysis. You also have the following information:

The firm has 15 million shares of common stock outstanding that are trading for $19.20 per share. The current

yield to maturity on 10-year Treasury Bonds is 3.00%. ABC's equity beta = 1.4. The market risk premium

= 6.2254%. The firm's bonds have a 6.5%/yr. coupon rate, have a $1,000 face value, pay semi-annual

coupons, and mature in 15 years. There are 100,000 bonds outstanding and they currently sell in the open

market for $960.00 per bond.

Sales projections are these for years 1-5: $300,000, $420,000, $510,000, $600,000, and $480,000.

The MACRS depreciation schedule for a 7-year asset is as follows: year 1: 14.29%; year 2: 24.49%; year 3:

17.49%; year 4: 12.49%; year 5: 8.93%; year 6: 8.92%; year 7: 8.93%; and year 8: 4.46%.

Next, here is the schedule for the various working-capital accounts that will be affected if the project is undertaken:

time 0 1 2 3 4 5

Accts. Receivable 0 27000 39000 45000 51000 0

Inventory 33000 45000 48000 60000 45000 0

Accounts Payable 21000 25200 24600 30000 168000 0

Eugene has requested that you (a) identify all of the cash flows for this project, (b) using

the weighted-average cost of capital as the discount rate, report the project's NPV and IRR, and

(c) provide your recommendation regarding whether the project should be accepted or rejected. The

details of your cost of capital calculations and cash-flow projections should be clearly presented.