Reference no: EM133056938

Lee Manufacturing Inc. currently has 2 million shares of common stock outstanding, with a price of $20 per share. Analysts estimate that the expected return on this common stock is 13%. Lee also has $25 million in debt outstanding with an expected pre-tax return of 5.5%. The corporate tax rate for Lee is 35%.

Lee is considering some new manufacturing equipment that will last 15 years and will increase annual revenues by $700,000 per year. This equipment will increase annual operating expenses (other than depreciation) by $270,000 per year. The equipment will cost $900,000 today and, for tax purposes, will be fully depreciated on a straight-line basis to a remaining book value of $0 over 15 years. However, management expects that it will be able to sell this equipment for scrap metal with a market value of $30,000 at the end of 15 years.

Assume that any gain or loss on the sale of the equipment is taxable (or tax-deductible) at the corporate tax rate. Should Lee acquire the machine? Why or why not?

Please give a detailed explaination