The engineering department at Digitech Inc. wants to buy a new state-of-the-art computer. The proposed machine is faster than the one now being used, but whether the extra speed is worth the expense is questionable given the nature of the firm’s applications. The chief engineer (who has an MBA and a reasonable understanding of financial principles) has put together an enormously detailed capital budgeting proposal for the acquisition of the new machine, which concludes that it’s a great deal. You’re a financial analyst for the firm and have been assigned to review the engineering proposal. Your review has highlighted two problems. First, the cost savings projected as a result of using the new machine seem rather optimistic. Second, the analysis uses an unrealistically low cost of capital.
With respect to the second point, the engineering proposal contains the following exhibit documenting the development of the cost of capital used.
Digitech's capital structure is 60% debt and 40% equity

The manufacturer is offering financing at 8% as a sales incentive

Cost of capital = 8% ( .6 = 4.8%

After tax this is 4.8% (1(T) = 4.8%(.6) = 2.9%

You’ve checked the market and found that Digitech’s bonds are currently selling to yield 14%, and the stock is returning about 20%. How would you proceed? That is, explain the chief engineer’s error(s) and indicate the correct calculations.