Reference no: EM132799090

Question - Two years ago, your company purchased a machine used in manufacturing for RM140,000. Although the machine had performed as expected, you have learned that a new machine is available that offers many advantages; you can purchase it for RM150,000 today, plus an additional RM10,000 in shipping and RM5,000 training costs. The new machine will be depreciated on a straight-line basis over five years and has no salvage value.

You expect that the new machine will produce a gross margin (revenues minus operating expenses other than depreciation) of RM40,000 per year for the next five years. Upon buying the machine, it requires inventories to increase by RM20,000 and accounts payable increase by RM10,000. The change in Net Operating Working Capital is expected to be fully recovered a year five.

The current machine is expected to produce a gross margin of RM20,000 per year. The current machine is being depreciated on a straight-line basis over a useful life of 7 years, and has no salvage value, so the depreciation expenses for the current machine is RM20,000 per year. The market value today of the current machine is RM90,000.

Your company's tax rate is 28% and the beta factor of this new investment is 1.5. The company has a target capital structure 50% equity and 50% debt. The cost of debt-after tax is 8%. The risk-free rate is 4% and the market risk is 8%.

Required -

a) Would you argue for the cost of shipping and training to be included in the calculation of initial outflow? Justify your answer.

b) What is the cost of equity for the new project?

c) Calculate the initial cash outflow associated with replacing the older printing machine with new machine.

d) Calculate the Net Present Value (NPV) if the company decided to buy new machine.

e) Should the company proceed with buying the new machine?