Example #$3$

A company is considering the acquisition of production equipment which will reduce both labor and materials costs. The cost is $$100,000$ and it will be depreciated on a straightline basis down to $$0.$ The useful life of the equipment is five years, and it will have a $$20,000$ market value at the end of five years. Operating costs will be reduced by $$30,000$ in the first year and the savings will increase by $$5,000$ per year in years $2,3,$ and $4.$ Due to increased maintenance costs, savings in year five will be $$10,000$ less than the year four savings. The equipment will also reduce net working capital by $$5,000$ throughout the life of the project. The firm's tax rate is $35$ percent and the required return is $16$ percent. Should the firm purchase this production equipment?