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Wells Printing is considering the purchase of a new printing press. The total installed cost of the press is $2.2 million. This outlay would be partially offset by the sale of an existing press. The old press has zero book value, cost $1 million 10 years ago, and can be sold currently for $1.2 million before taxes. As a result of acquisition of the new press, sales in each of the next 5 years are expected to be $1.6 million higher than with the existing press, but product costs (excluding depreciation) will represent 50% of sales. The new press will not affect the firm's net working capital requirements. The new press will be depreciated under MACRS, using a 5-year recovery period. The firm is subject to a 40% tax rate. Wells Printing's cost of capital is 11%. (Note: Assume that the old and the new presses will each have a terminal value of $0 at the end of year 6.)
a. Determine the initial investment required by the new press.
b. Determine the operating cash flows attributable to the new press. (Note: Be sure to consider the depreciation in year 6.)
c. Determine the payback period.
d. Determine the net present value (NPV) and the internal rate of return (IRR) related to the proposed new press.
e. Make a recommendation to accept or reject the new press, and justify your answer.
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