Quality Metal Works, Inc., is considering a proposal to buy a new furnace for $2,500,000 (all costs

Question:

Quality Metal Works, Inc., is considering a proposal to buy a new furnace for $2,500,000 (all costs included). The furnace will have a useful life of 10 years, with no expected salvage value at the end of its life. The firm requires a rate of return of 8% on all its investments. For convenience, assume that cash flows occur at the end of each year. Assume straight-line depreciation for tax purposes.

The applicable tax rate is 30%.

Required:

a. Ignore the depreciation tax shield. What are the minimum annual cash inflows that this furnace must generate for the company to justify the investment?

b. How much is the annual depreciation tax shield? What is the present value of the depreciation tax shield?

c. If you take into account the depreciation tax shield, will the minimum annual cash inflows from operations (pretax) needed to justify this investment increase or decrease? By how much?

Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important...