Question 1

Assume that you work for a small body shop that repairs cars. The industry is undergoing consolidation, as big companies who can work with the car manufacturers and insurance companies at scale are taking more and more market share.

The biggest piece of machinery in your shop has been on its last legs for years. It finally broke yesterday and is beyond all repair. Without it, you will have to sell the business. Should you fix it?

Cost of new machine: $100,000

Life of new machine: 5 years (5 year depreciation schedule)

Revenue of Shop:$700,000 per year

Expenses of Shop:$300,000 per year

Sale price of business:$1 million

Current book value of business:$0

Tax Rate:30% for income tax, 15% for capital gains

Cost of Capital:9%

Inventory level required to operate business:$80,000

Question 2

Assume that you have decided to go ahead and keep the business so that you can continue paying yourself a salary. However, as an alternative, you could buy a cheaper version of the broken machine that costs $15,000 but will only last one year. We will call this Option B (Option A is the new machine outlined in question 1). Should you purchase Option A or Option B? Show all your work.