70.2K

Verified Solution

Link Copied!

CapBud Manutacturing LTD is planning the purchase of new fully automated machine to replace the old manually operated one ,which has been operating in the factory for the last 6 years .When the new machine replaces the old machine ,the old machine will be sold immediately ( l.e.today )for $ 15,000.The old machine has a cost of $ 20,000

with an estimated useful life of 10 years. All machines are fully depreciable over their expected lives using straight line depreciation to a zero-book value. The new machine has a cost of $ 50,000 and is estimated to last for 4 years.

There will be no changes in net working capital.

Maintenance workers need special training to use the new machine because the new machine involves recent IT technology advancements. However, the company purchased similar machine 5 months ago and at that time spent $10,000 training workers and workers need no further additional training to use the new machine.

The company finances the investment through shares and bonds issuance. The company's 6% p.a. semi-annual coupon bonds with par value of $ 1,000 are selling for $ 942.65 with 10 years remaining until maturity. The company has a beta of 1.2. The market risk premium is expected to be 5% and the current risk-free rate is 7%. The company also has target capital structure of 70% common stock and 30% debt. The company's marginal corporate tax rate 35%.

Required:

a) Calculate the company's weighted average cost of capital (WACC). Briefly explain what the WACC for a company is and why it is often used as a discount rate to evaluate projects. [ 2marks ]

b) Explain whether or not the $ 10,000 spent on the maintenance workers' training program is an incremental cash flow with respect to the decision to purchase the new machine and replace the old machine. [ 2marks ]

C) Calculate the investment's initial outlay (Year0). [ 2 marks]

d) Assuming that the incremental operating cash flow for Year 1 to 3 are $ 17,325 per year; and the terminal cash flow for Year 4 is $28,825, should the company replace the old machine with the new machine? Justify your decision using the appropriate decision tools. [ 2 marks]

Answer & Explanation Solved by verified expert

See Answer