Question 2 You have been asked to evaluate the proposed purchase of a new machine by your company, Sprockets and Widgets. The price of the new machine is 250,000, and it will cost an additional 25,000 to adapt it to the company's purpose. The company might try to sell the machine after 5 years, but it is very unlikely to get a meaningful (material) price. Depreciation is based on the straight-line method. Use of the machine would require an increase in net working capital of 15,000, which would be recovered in the final year of the investment. The machine is expected to save the firm 50,000 per year in operating costs. The corporate tax rate is 40%. Required: a. What is the initial investment outlay associated with the machine purchase? b. What is the terminal cash flow in year 5? c. Critically examine the treatment of working capital in the above case. d. If the project's required rate of return is 15%, should the equipment be purchased? e. Undertake a detailed critical evaluation of how Sprockets and Widgets could increase the NPV of the project by using debt finance. Question 2 = 25 marks Question (d). Given in the Question that, cost of capital is 15% We have also arrived that, Initial investment outlay = 290,000 Annual cash inflow from year 1 to 4 = annual after tax savings + tax savings due to depreciation = 30,000 + 20,000 = 50,000 Terminal cash inflow = 65,000 Now we need to compute NPV of the project to evaluate whether the equipment should be purchased or not. If NV is positive then the equipment is purchased. If NPV is negative then the equipment is not purchased. The NPV computation is as follows, NPV = PV of all the ash inflows - initial outlay NPV = 50,000 * PV factor annuity @15% for 4 years + 65,000 * PV factor @15% for 5th year - 290,000 NPV = [50,000 * 2.854978363] + [ 65,000 * 0.497176735] - 290,000 NPV = 142,748.9181 + 32,316.48779 - -290,000 Therefore NPV = -114,934.5941 It is observed that the NPV of the project is negative. Hence the equipment should not be purchased if the required rate of return or cost of capital is 15%