Reference no: EM133276189

Assume that the company is considering adding a new product line at one of its facilities. The addition would increase the firm's capacity by almost 120% and improve production efficiency. The equipment required for the new production line will cost $3.9 million and requires $100,000 in installation costs. It will have an estimated life of 10 years, at which time it can be sold for an estimated after-tax scrap value of $300,000. Furthermore, at the end of five years, the production line will have to be refurbished at an estimated cost of $2 million. Management estimates that the new production line will add $850,000 per year in after-tax cash flow to the firm. The expected after-tax cash inflows from years 1 to 10 are provided in the following table:

Assume a discount rate of 9%.

Questions:

1. Will the purchase of the new production line create value for the firm? Justify your answer using the NPV method. Show all calculations. 

2. Calculate the internal rate of return and profitability index for the proposed production line and explain whether the purchase should be made. Show all calculations. 

3. Calculate the payback period and discounted payback period. Report the results in a table and explain your findings. 

4. Comment on the decision to purchase the new production line, given all the findings from different capital budgeting methods that you have used.