A project will purchase a machine for the computer-aided manufacture. The installation fee of the...
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A project will purchase a machine for the computer-aided manufacture. The installation fee of the machine is $40 million in year 0. The machine increasess tax-deductible depreciation of $20 million per year for the next three years. The machine has a cost savings of $30 million per year for the next three years. The project would also necessitate increasing inventories by $3 million per year and accounts receivable by $1 million per year and accounts payable by 2 million per year in years 0, 1 and 2. The working capital will be fully recovered at the end of the project (year 3). Assume that the other cash flows are not material. The corporate tax rate is 30% and the firm maintains a constant debt to value ratio of 40%. At this debt to value ratio, the cost of debt for the firm is 7%. The risk free rate is 6% and the market risk premium is 5% The beta of the precision tools project is 2.0 (a) Calculate the cost of capital for the project. (b) Calculate the net present value of the project using the WACC method. (c) Using the information given above, suggest a method to estimate the present value of the tax shields on debt generated by this project. You do not have to compute the present value of the debt tax shield.
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