Question
Xtra Mechanical, Inc. is a manufacturer of machine parts with locations in the United States. It is considering entering into a ten year supply agreement
Xtra Mechanical, Inc. is a manufacturer of machine parts with locations in the United States. It is considering entering into a ten year supply agreement with a customer where it will supply certain parts to the customer for their products. It will require Xtra to purchase a new machine and incur additional costs. The cost of the machine is $8,500,000 and will require additional annual costs of 7.0% of revenues. There is an initial working capital investment of $15,000 and annual working capital investments of $15,000 will be required except in the last year, as the project terminates no working capital will be needed and all of the working capital investment over the years is returned in the final year. Revenues from the contract per year are shown below. Cost of goods sold is expected to be 50% of revenues. At the end of its life it is expected the machine can be sold in the used market for 20% of the original cost. Five year MACRS depreciation will be used for tax purposes and the company's average tax rate is 23% and the marginal rate is 25%. Given the risk level of this project Xtra requires a rate of return 1% above its weighted cost of capital. Its weighted cost of capital is 10%.
Prepare an analysis to determine if this project will generate an attractive level of economic benefits. Specifically determine the net present value and internal rate of return.
Should the project be accepted or rejected and why?
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