ATC Corporation is a manufacturer of new and replacement parts for the aircraft industry. The companys major customers are airlines, other aircraft operators (such as charter services), and contract maintenance service providers. Despite the economic slowdown, the company expects its sales to be strong for the several years, since many aircraft operators will be more interested in maintaining and repairing existing planes rather than buying new ones.

At the present time, ATC is considering an upgrade to its manufacturing facility. This will involve replacing several older machines by the purchase and installation of a new, state of the art, computer-controlled metal cutting and shaping machine center made by a German supplier. Estimates of the machine centers costs and benefits are shown in the table below, where net cash flows are after-tax. Although the machinery should last for at least ten years, the company uses a five-year planning period for equipment of this type (based on depreciation rules and company policy). Since the machine will not be sold at the end of year 5, there is no salvage value to consider.

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Initial Costs:
Purchase	-3,600,000
Shipping	-150,000
Installation	-250,000
Cash Inflows:
Sale of Old Machines	200,000
Investment Tax Credit	350,000
After-Tax Cost Savings		400,000	420,000	440,000	460,000	480,000
After-Tax New Sales		0	50,000	100,000	120,000	150,000
Depreciation Tax Savings		350,000	600,000	430,000	300,000	200,000
Increased Product Quality		10,000	20,000	25,000	30,000	35,000
Net Cash Flows:	-3,450,000	760,000	1,090,000	995,000	910,000	865,000

Three important things to note are that the above cash flows have been adjusted to include an assumed inflation rate of 3% per year, the companys average tax rate is 30%, and that the investment project is considered to be 20% riskier than the companys average investment.

Examination of ATCs balance sheet reveals that the company uses the following types of financing (all percentages are based on market value).

Financing Type	Percentage of Total Financing	Market Rate of Return
Short-Term Debt	15%	3.5%
Long-Term Debt	30%	5.25%
Preferred Equity	10%	8%
Common Equity	45%	12%

If ATC does not make this equipment investment, it has no other real asset investment projects which it is considering. Therefore, an alternative use of the money in the capital budget would be a purely financial investment, such as stock, bonds, short-term CDs, and so forth.

1.Based on your knowledge of current and projected economic conditions, does the companys assumption about future sales sound reasonable to you? Why or why not?

2.What cost of capital should the company use to analyze this investment project?

3.Without considering any other alternatives, is the machine a good investment for the company? Why or why not?

4.Without doing any calculations, discuss some possible alternatives which the company might have in terms of financial investments. Give some specific examples and make sure that you include a consideration of risk as part of your discussion.

5.Which choice would you recommend for the company? Why do you consider this option the best choice?

6.Suppose you are convinced that inflation over the next several years will be higher than the 3% which is forecast in the numbers the company is using in their projections. Without doing any further calculations, explain how you could adjust your analysis to account for this.