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3. The Huron Development Company is considering buying an overhead pulley system. The new system has a purchase price of $100,000, an estimated useful
3. The Huron Development Company is considering buying an overhead pulley system. The new system has a purchase price of $100,000, an estimated useful life and MACRS class life of five years, and an estimated salvage value of $30,000. It is expected to allow the company to economize on electric power usage, labor and repair costs, as well as to reduce the number of defective products. A total annual savings of $5,000 will be realized if the new pulley system is installed. The company is in the 30% marginal tax bracket. The initial investment will be financed with 40% equity and 60% debt. The before-tax debt interest rate, which combines both the short-term and long-term financing, is 15% with the loan to be repaid in equal annual installments over the project life. The equity interest rate (ie), which combines the two sources of common and preferred stocks, is 20%. a. Evaluate this investment project by using net equity flows. b. Evaluate this investment project by using k (cost of capital).
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