Assess Capital Budgeting Problems – Replacement Project
Write a technical report:
Assume that a company’s machine was bought 10 years ago at a cost of $200,000. The machine had an expected life of 20 years at the time it was bought with a $0 salvage value. The annual depreciation expense is $10,000 and the current book value is $100,000. The market value of this machine is $90,000. A company is considering buying a new machine that costs $140,000, which has a projected 10-year life. The new machine is expected to reduce the firm’s operating expenses from $30,000 to $12,000. With the new machine, the firm’s pre-tax profits are anticipated to increase by $18,000 per year.
If the company buys this new machine, the old machine will be sold. It’s projected that the new machine can be sold for $5,000 at the end of its life. The cost of capital is calculated based upon funding from retained earnings and from debt. The company is assumed to fund itself with 40% debt and 60% retained earnings. The cost of debt capital, rD, is 8%. The cost of capital from retained earnings, rS, is based upon the Capital Asset Pricing Model. The risk-free rate in the market is 3% and the difference between the expected return on the market and the risk-free rate is 5%. The beta of the company is 1.5. The tax rate is assumed to be 35%.
Should the company buy a new machine?
Use and provide a copy of the Excel for spreadsheet for the calculations.
