A salsa manufacturer named Barbosa and Da Rosa Inc. (Ticker: BEAR) is looking to maximize its shareholders wealth. The CEO feels that the firm needs a new $350,000 tomato washing and dicing machine to get it through the next three years. The firm would incur shipping, installation, and training costs of $4,500 for this new machine, plus fixed operating costs of $20,000 in the first year. These fixed costs should rise by the rate of inflation each year. In comparison, the firm would incur fixed costs of $28,000 over the first year if it kept its current tomato washing and dicing machine, which would also rise by the rate of inflation each year. The old machine is fully depreciated, but the new machine will be depreciated over a seven-year MACRS schedule. At the end of three years, the old machine would have no value, but the new machine would be worth $20,000.

With both machines, sales will increase by 5% per year after the first year. If the new machine is purchased, the firm will sell 253,000 jars of salsa in the first year. If the new machine is not purchased, the firm will sell 220,000 jars of salsa in the first year. Regardless of which machine they use to wash and dice the tomatoes, the variable costs per jar will be $2.50, and sales price will be $6.00 per jar. These prices will not change over the three-year life of the project.

If BEAR buys the new machine, it will change its net working capital. It will make one-time increases of $80,000 in cash, $120,000 in accounts receivable, and $70,000 in accounts payable. These values will be fixed over the life of the project and the increases will occur at the very beginning of the project.

BEAR common stock is currently trading at $4.37. There are 190,750 shares of common stock outstanding. It has not paid a dividend in many years. The common stock has the same amount of systematic risk as the market. BEAR also has an issue of $1000-par value preferred stock on the market. The preferred stock currently sells for $1,137.93. The annual dividend on the preferred stock is 7.5% of par. There are 100 shares outstanding. BEAR also has bonds outstanding that were issued with a total face value of $872,000. These bonds pay an annual coupon rate of 9%, and make annual coupon payments. They have six years left until maturity, and have an annual yield to maturity of 9.6%. The current rate on the T-bill is 4.93%. Inflation will be 3%. The market return is 13.13%. BEARs tax rate is 40%.

If BEAR invests in the new machine, they will also change their capital structure. The firm will issue new debt in the amount necessary to retire all of the preferred stock. The cost of debt will not change, but the beta of the common stock will increase to 1.1.

Should BEAR invest in the tomato processing machine?