Question 2 (20 marks) Zakk Wylde and Co. is conducting an analysis on whether to purchase a machine to make guitar strings or not. Before purchasing the machine, the company has paid a consultant $15,000 to conduct a market analysis. The machine costs $60,000. It occupies a space that the company can be sold for $20,000 and it can last for five years. You may assume that the company can sell the space after five years at the same price (after tax). The machine can be sold at $20,000 in year five. Terminal value for the machine (book value) is $8,000 and the company uses a straight line depreciation method. After purchasing this machine, the company can sell 1,500 packs of guitar strings per year at $25 per pack. The number of packs sold will grow at 4% per year for the following five years. Price of guitar strings is assumed to grow at 3% per year for the following five years as well. Variable cost for making guitar strings is $9 per pack. This will remain unchanged for the following five years. Fixed cost is $8,000 per year for the first two years and increases to $10,000 per year for the following three years. The company needs $500 of initial investment in net working capital, and they can recover such net working capital when the project ends. Tax rate is 34%. 1) What are the operating cash flows for year 1 to year 5? (5 marks) 2) What is the NPV of purchasing this machine if cost of capital is 12%? Should the company go ahead and purchase the machine? (8 marks) Assume now that the manager of Zakk Wylde and Co. knows that the seller of the machine will offer them an upgrade to the machine in year one. The upgrade will cost the company an extra $5,000 (in year one). After the upgrade, variable cost for making guitar strings will be $5 per pack, assuming that the machine's life does not change (i.e. there are only four years left after the upgrade) and everything else are the same. 3) Should the company go ahead and purchase the machine now? What should the company do to make this a profitable project? (7 marks) Question 2 (20 marks) Zakk Wylde and Co. is conducting an analysis on whether to purchase a machine to make guitar strings or not. Before purchasing the machine, the company has paid a consultant $15,000 to conduct a market analysis. The machine costs $60,000. It occupies a space that the company can be sold for $20,000 and it can last for five years. You may assume that the company can sell the space after five years at the same price (after tax). The machine can be sold at $20,000 in year five. Terminal value for the machine (book value) is $8,000 and the company uses a straight line depreciation method. After purchasing this machine, the company can sell 1,500 packs of guitar strings per year at $25 per pack. The number of packs sold will grow at 4% per year for the following five years. Price of guitar strings is assumed to grow at 3% per year for the following five years as well. Variable cost for making guitar strings is $9 per pack. This will remain unchanged for the following five years. Fixed cost is $8,000 per year for the first two years and increases to $10,000 per year for the following three years. The company needs $500 of initial investment in net working capital, and they can recover such net working capital when the project ends. Tax rate is 34%. 1) What are the operating cash flows for year 1 to year 5? (5 marks) 2) What is the NPV of purchasing this machine if cost of capital is 12%? Should the company go ahead and purchase the machine? (8 marks) Assume now that the manager of Zakk Wylde and Co. knows that the seller of the machine will offer them an upgrade to the machine in year one. The upgrade will cost the company an extra $5,000 (in year one). After the upgrade, variable cost for making guitar strings will be $5 per pack, assuming that the machine's life does not change (i.e. there are only four years left after the upgrade) and everything else are the same. 3) Should the company go ahead and purchase the machine now? What should the company do to make this a profitable project? (7 marks)