Question
A firm is considering a major expansion of its operations. If it expands, the firm anticipates an initial investment in equipment of $500,000 that will
A firm is considering a major expansion of its operations. If it expands, the firm anticipates an initial investment in equipment of $500,000 that will be depreciated via straight-line depreciation over 5 years. The projected cash inflows are $200,000, $250,000, $200,000, $200,000, and $150,000, respectively, over the 5 years. At that time the resale value of the equipment is estimated to be $125,000. The marginal tax rate is 35 percent, and the opportunity cost of capital is 15 percent. a. Should the investment be made? b. After running the analysis in (part a) you remember that if the investment is made the firm will have to use a building that is presently rented out for $70,000 per year (before taxes) payable in advance (i.e., at t = 0, t = 1,..., t = 4). Does this new information affect the decision you reached in (a)?
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