A company with a cost of capital of 12.75 per cent per annum wishes to...
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A company with a cost of capital of 12.75 per cent per annum wishes to evaluate the purchase of new fixed equipment for $455,000, plus installation costs of $25,000. The equipment should generate extra revenue of $163,000 per annum for the next 4 years but add to operating costs in the factory by $24,000 per annum for those 4 years. The company intends to sell the equipment after 4 years for an anticipated $185,000. The equipment can be depreciated for tax purposes on a straight-line basis over 6 years, giving a salvage or written down value of $160,000 after 4 years. The company tax rate is 30 per cent.
Should the company purchase the equipment?
Hint: First, construct a capital budgeting Excel template to derive net cash flows. Second, apply both NPV and IRR rules to determine whether or not undertake this project.
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