Sigma Inc. is planning to replace their existing equipment with a newer version that will increase productivity significantly. It will produce goods with more consistent quality, allowing the firm to increase prices. Consequently, sales are expected to increase by $100,000 and operating costs will be reduced by $50,000. The new machine will cost $500,000 with an economic (and depreciable) life of 5 years. The old machine has been fully depreciated to a book value of zero and can be sold currently for $50,000. Net working capital of $25,000 will be required in year 0 and none thereafter.

a) If the company has a cost of capital of 15%, should they purchase this new machine? Assume the effective tax rate is 30%.

b) Explain how net working capital is used in NPV analysis to grandmother.