Sawdust Ltd. needs to purchase a new machine. It has narrowed its options to two models: the Dust Grinder and the Saw Mill. Both machines have useful lives of five (5) years. Purchase of these machines would result in the following net after-tax cash flows:

 

Year	Dust Grinder     $	Saw Mill
0	320 000	360 000
1	176 000	260 000
2	136 000	120 000
3	60 000	4 000
4	56 000	20 000

 

The firm's target capital structure is 40% debt, 10% preferred stock and 50% equity.

The after-tax cost of debt is 6%, of preferred stock, 12.5% and common equity has a cost of 15.5%

 

Required

(a)Compute the cost of capital

(b)Use the NPV method to identify which machine thecompany should purchase.

(c)When the cash flows of the machines are discounted at 18%, their NPVs are:

 

Dust Grinder   -$2 760

Saw Mill   - $36 804

 

(d)Compute the IRR for each machine

(e)Based on your conclusions in b and c above, whichmachine should the firm purchase? Explain your decision