Reference no: EM133068282
Aluminium with a unit it purchased several years ago. The old unit currently has a book value of $500,000 which originally cost $1,000,000. The existing unit is being depreciated at a rate of $50,000 per year. Origami expects to sell the existing machine for $575,000.
Origami is considering replacing the existing unit with a newer, more efficient one. The new unit will cost $1,500,000 and will also require an initial increase in net working capital of $80,000. The new unit will be depreciated on a straight-line basis over 5 years to a zero balance. Origami expects a salvage value of $150,000 after the new unit's useful life is over. Corporate tax rate is 40 percent.
If Origami purchases the new unit, due to increased capacity, the annual revenues are expected to increase by $200,000. It is also expecting a reduction in annual operating costs (exclusive of depreciation) by $40,000. Annual revenues and operating costs are expected to remain constant at this new level over the 5-year life of the project. Origami estimates that its net working capital investment will increase by $20,000 per year over the first 4 years of the project's operation. Accumulated net working capital will be recovered at the end of 5 years.
Origami's balance sheet is below:
Current assets - $400,000
Fixed assets - 2,000,000
Debt - 960,000
Share capital - 1,440,000
Origami's equity beta is 1.3, cost of debt is 10% and the risk-free rate and market return are 8% and 14% respectively.
-Calculate the project's initial net investment.
-Calculate the annual net operating cash flows for the project.
-Show and calculate the project's terminal cash flow.
-Calculate Origami's cost of equity and the weighted average cost of capital for the project
-Should Origami proceed with the project? Why?
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