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Kingston Ltd is going to evaluate if it should invest in a new project that produces smartphones. The project requires a new machine and it
Kingston Ltd is going to evaluate if it should invest in a new project that produces smartphones. The project requires a new machine and it will cost $200,000. The machine will last for five years and it will be fully depreciated to zero over the project's five-year life. However, the manager can still sell the machine by the end of year five for $50.000 before tax. Price per unit of smartphone is expected to be $18 per set for the all five years and unit sales are 6,000 per year for the five years. In order to produce the smartphones, variable costs constitute 35% of total sales and the manager also needs to spend $8,000 in fixed cost every year. In order to make sure that the business is functioning smoothly, manager needs to make initial investment $60,000 in net working capital, which could be recovered after the project ends in year five. This project is all- equity financed and its stock has a beta of 1.15. Risk-free rate is 3.8% and market premium is 7.5% Tax Rate is 16% C. If the firm has been given an option to buy a more powerful machine with an extra $20,000 (this extra cost is also depreciable) in year and this machine can reduce the fixed cost to $5.000 every year. Should it buy the more powerful version? (6%)
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