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Case I: Capital budgeting (10 Marks) Tough Steel, Inc. is a processor of carbon, aluminum, and stainless steel products. The form is considering replacing an old stainless weel tube making machine for more cost-effective machine that can meet the firm's quality standards. The old machine was acquired 2 years ago at an installed cost of $500,000. It has been depreciated under the MACRS's 5-year recovery period, and has a remaining economic life of years. It can be sold today for $300.000 before taxes, but If the firm decides to keep it, it can be sold for $100.000 before taxes at the end of year 5 The first option is Machine A, which can be purchased for $600,000, but will require $30,000 in installation costs. This machine would be depreciated under the MACRS's 3-year recovery period. At the end of its economic life, the machine will have a salvage value of $150,000 before taken. This machine would require an investment in net working capital of $10,000 The second option is Machine B, which can be purchased for $550,000, but requires $20,000 in installation costs. This machine would be depreciated under the MACRS's 5-year recovery period, At the end of its economic life, the machine would have a salvage value of $330,000 before taxes This machine requires investment in net working capital of $10,000. The firm has estimated the following EBIT for all three machines: Calculate the initial investment, annual after-tax cash flows, and the terminal cash flow of each investment project. Calculate the payback period, NPV, and IRR of each investment project. Should the firm accept or reject one or both projects? The firm's WACC is 12% and its tax rate is 35% Year 1 2 3 4 5 Old machine $90,000 $100,000 $120.000 $150.000 S150.000 EBIT Machine A S100.000 $30,000 $80,000 S150,000 $220,000 Machine B $120,000 $140,000 SI 50.000 $200,000 $220.000 MACRS schedules Year 1 2 3 4 3 33.33% 44,44% 14.81% 7.41% Equipment Life (Years) 5 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 7 14.29% 24.49% 17.49% 12.49% 8.92% 8.929 5 6 Case I: Capital budgeting (10 Marks) Tough Steel, Inc. is a processor of carbon, aluminum, and stainless steel products. The form is considering replacing an old stainless weel tube making machine for more cost-effective machine that can meet the firm's quality standards. The old machine was acquired 2 years ago at an installed cost of $500,000. It has been depreciated under the MACRS's 5-year recovery period, and has a remaining economic life of years. It can be sold today for $300.000 before taxes, but If the firm decides to keep it, it can be sold for $100.000 before taxes at the end of year 5 The first option is Machine A, which can be purchased for $600,000, but will require $30,000 in installation costs. This machine would be depreciated under the MACRS's 3-year recovery period. At the end of its economic life, the machine will have a salvage value of $150,000 before taken. This machine would require an investment in net working capital of $10,000 The second option is Machine B, which can be purchased for $550,000, but requires $20,000 in installation costs. This machine would be depreciated under the MACRS's 5-year recovery period, At the end of its economic life, the machine would have a salvage value of $330,000 before taxes This machine requires investment in net working capital of $10,000. The firm has estimated the following EBIT for all three machines: Calculate the initial investment, annual after-tax cash flows, and the terminal cash flow of each investment project. Calculate the payback period, NPV, and IRR of each investment project. Should the firm accept or reject one or both projects? The firm's WACC is 12% and its tax rate is 35% Year 1 2 3 4 5 Old machine $90,000 $100,000 $120.000 $150.000 S150.000 EBIT Machine A S100.000 $30,000 $80,000 S150,000 $220,000 Machine B $120,000 $140,000 SI 50.000 $200,000 $220.000 MACRS schedules Year 1 2 3 4 3 33.33% 44,44% 14.81% 7.41% Equipment Life (Years) 5 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 7 14.29% 24.49% 17.49% 12.49% 8.92% 8.929 5 6
