Reference no: EM132909133

A toy company just spent $10,000 to do an analysis and determined that a new machine would help meet the increased demand for toys. So the company is considering investing in a new machine today. The cost of the machine is $100,000 and the machine is to be fully depreciated over 10 years using the straight-line depreciation method. The machine will be placed in a factory that is currently being rented out at $1,000 per year, and the current tenant will need to be evicted. The new machine will produce 1,000 toys, which will be priced at $11 each. The cost per toy is $1 each. At the end of 2 years, you expect production will cease and you will be able to sell the machine for $80,000.

It is estimated that the firm needs to hold net working capital equal to 10% of total sales and that it will need to be injected today if the machine is purchased. The NWC balance will be withdrawn at the end of the project. The firm is in the 10% tax bracket and the opportunity cost of capital is 10%.

Problem (a) Estimate the after-tax cash flows for the project using the accounting flow and the cash flow table. IMPORTANT: You must show each input in your table as a separate row. DO NOT group inputs together.

Problem (b) Using NPV analysis, should the company go ahead with the project? (3 marks)

Problem (c) Discuss why would the firm requires the change of the net working capital and discuss the logic of your adjustment in part (a).

Problem (d) Would the IRR give you the same conclusion as the NPV decision rules for this project? Explain.

Problem (e) Calculate the payback period of this project, what would be your decision if the payback period threshold is 2 years?

Problem (f) You are choosing between 3 machines. Option 1 will last 3 years and has a NPV of -$1 million; Option 2 will last 4 years and has a NPV of -$2 million; Option 3 will last 5 years and has a NPV of -$3 million. Assume a cost of capital of 10%. Which machine do you choose, assuming they can be replaced indefinitely?