Reference no: EM132958033

You are looking at investing in a project that will require the purchase of machinery that costs $15,000,000 and can be sold for $4,200,000 in ten years.

• The old machinery can be resold today for $2,500,000 and could have been salvaged for $800,000 in ten years.
• The new project will increase revenues by $2,200,000 and expenses by $950,000 while incurring a $200,000 increase in net working capital that will be recovered at the end of the project.
• The equipment is in the 25% CCA bracket and the 35% tax bracket. 
• The weighted average floatation costs required to fund the purchase are 7.5%.
• Currently the firm is financed by 2 types of equity and one form of debt. 
• The debt to equity ratio is 0.9 and the market value of class A equity is twice that of class B equity.
• The covariance between the equity returns for equity A and those of the market is 0.001519 while the variance of the market returns is 0.001215.
• Currently risk free t-bills are yielding 2% while the expected return on the market is 12%.
• Equity B just paid a dividend of $2.75 which is expected to grow at 2% indefinitely and is priced at $35.06.
• The debt is in the form of ten year bonds with annual coupons and compounding. 
• The bonds are selling on the market at $1,067.10 and are pay a 9% coupon, with a $1,000 face value.
  

Problem 1: Should you replace the machine?