Holmes Manufacturing is considering a new machine that costs $285,000 and would reduce pretax manufacturing costs by $90,000 annually. The new machine will be fully depreciated at the time of purchase. Management thinks the machine would have a value of $23,000 at the end of its 5-year operating life. Net operating working capital would increase by $25,000 initially, but it would be recovered at the end of the project’s 5-year life. Holmes’s marginal tax rate is 25%, and a 10% WACC is appropriate for the project.

a. Calculate the project’s NPV, IRR, MIRR, and payback.

b. Assume management is unsure about the $90,000 cost savings—this figure could deviate by as much as plus or minus 20%. What would the NPV be under each of these situations?

c. Suppose the CFO wants you to do a scenario analysis with different values for the cost savings, the machine’s salvage value, and the net operating working capital (NOWC)

requirement. She asks you to use the following probabilities and values in the scenario analysis:

Calculate the project’s expected NPV, its standard deviation, and its coefficient of variation. Would you recommend that the project be accepted? Why or why not?

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Scenario Worst case Base case Best case Probability 0.35 0.35 0.30 Cost Savings $ 72,000 90,000 108,000 Salvage Value $18,000 23,000 28,000 NOWC $30,000 25,000 20,000