Question
The CSI Corporation is looking to replace an existing printing press with one of two newer models that are more efficient. The current press is
The CSI Corporation is looking to replace an existing printing press with one of two newer models that are more efficient. The current press is three years old, cost 32,000 and is being depreciated under MACRS using a 5-year recovery period. The first alternative under consideration, Printing Press A, cost $40,000 to purchase and $8,000 to install. It has a 5 year usable life and will be depreciated under MACRS using a 5-year recovery period. The second alternative, press B cost $54,000 to purchase and $6,000 to install. It also has a 5 year usable life and will be depreciated under MACRS using a 5 year recovery period. The purchase of press A would result in a $4,000 increase in net working capital, and the purchase of Press B would increase net working capital by $6,000. The projected Earnings before depreciation interest and taxes for each alternative is presented below.
Year | Press A | Press B | Existing press |
1 | 25,000 | 22,000 | 14,000 |
2 | 25,000 | 24,000 | 14,000 |
3 | 25,000 | 26,000 | 14,000 |
4 | 25,000 | 28,000 | 14,000 |
5 | 25,000 | 28,000 | 14,000 |
The existing press can currently be sold for $18,000 before taxes. At the end of the 5 years the existing press can be sold for $1,000 before taxes. Press A can be sold to net $12,000 before taxes and press B can be sold to net $20,000 before taxes at the end of the 5 year period. The firm is subject to a 40% tax rate.
The company has $100M of debt outstanding with a yield-to-maturity of 8%, and has $150M of equity outstanding with a beta of 0.9. The expected market return is 13% and the risk-free rate is 5%.
1) What is the discount rate?
2) What is the before tax cost of debt?
3) What is the cost of equity?
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