Question
3) A mining company is considering whether to buy a new digger. The price of the machine is $150,000, and it will be depreciated using
3) A mining company is considering whether to buy a new digger. The price of the machine is $150,000, and it will be depreciated using straight-line depreciation over an expected lifetime of seven years. The equipment is expected to save $80,000 per year in labor costs, in current (year 0) dollars. The company's tax rate is 35%. The company expects that labor costs will increase at an annual rate of 8%, while the general rate of inflation of other goods and services in the economy is estimated at 6%.
(a) Determine the cash flows for this investment in nominal dollars, for years 0 through 7.
(b) Determine the project cash flows for this investment in constant dollars (i.e., dollars of constant purchasing power).
(c) If the company has a minimum acceptable rate of return of 20% after taxes in real dollars, is this new digger a good investment?
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