Reference no: EM132623245
Company X is deciding when to replace its old machine. The machine's current salvage value is €2.2 million. Its current book value is €1.4 million. If not sold, the old machine will require maintenance costs of €845,000 at the end of the year for the next five years. Depreciation on the old machine is €280,000 per year. At the end of five years, it will have a salvage value of €120,000 and a book value of €0. A replacement machine costs €4.3 million now and requires maintenance costs of €330,000 at the end of each year during its economic life of five years. At the end of the five years, the new machine will have a salvage value of €800,000. It will be fully depreciated by the straight-line method. In five years a replacement machine will cost €3.2 million. Company X will need to purchase this machine regardless of what choice it makes today. The corporate tax rate is 25% and the company is assumed to earn sufficient revenues to generate tax shields from depreciation.
The firm's capital structure is as follows:
- Debt: 50,000 6% bonds outstanding maturing in 25 years and selling for 100% of par; coupons are paid semiannually; par value is €1000.
-Commom stock: 800,000 stocks selling for €35 per share; beta is 1.25.
-Preferred stocks: the firm has 100,000 preferred shares outstanding trading at €20 each and paying a 2.5% dividend (with a face value of €100).Market index return is expected to be 15%; and return on T-bills is 5%.
(a) What is the weighted cost of capital (WACC)?
(b) Should Company X replace the old machine now?