Reference no: EM133179299
Question - Sawdust Ltd. needs to purchase a new machine. It has narrowed its options to two models: the Dust Grinder and the Saw Mill. Both machines have useful lives of five (5) years. Purchase of these machines would result in the following net after-tax cash flows:
|
Year
|
Dust Grinder $
|
Saw Mill
|
|
0
|
320 000
|
360 000
|
|
1
|
176 000
|
260 000
|
|
2
|
136 000
|
120 000
|
|
3
|
60 000
|
4 000
|
|
4
|
56 000
|
20 000
|
The firm's target capital structure is 40% debt, 10% preferred stock and 50% equity.
The after-tax cost of debt is 6%, of preferred stock, 12.5% and common equity has a cost of 15.5%
Required -
(a) Compute the cost of capital
(b) Use the NPV method to identify which machine thecompany should purchase.
(c) When the cash flows of the machines are discounted at 18%, their NPVs are:
Dust Grinder -$2 760
Saw Mill - $36 804
(d) Compute the IRR for each machine.
(e) Based on your conclusions in b and c above, which machine should the firm purchase? Explain your decision.
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