Manchester Company is considering a proposal to purchase special equipment at a cost of \($640,000.\) The equipment will be useful for five years and has an expected \($60,000\) salvage value. Manchester expects annual savings in cash operating expenses (before taxes) of \($230,000.\) For tax purposes, the annual depreciation deduction will be as follows (salvage value is ignored on the tax return):

The income tax rate is 40%. Manchester establishes a cutoff rate for a net present value analysis at the company’s weighted average cost of capital plus 2 percentage points. Manchester’s capital is provided in the following proportions: debt, 70%; common stock, 20%; and retained earnings, 10%. The cost rates for these capital sources are debt, 8%; common stock, 12%; and retained earnings, 10%.
Required

a. Compute Manchester’s (1) weighted average cost of capital and (2) cutoff rate.

b. Using Manchester’s cutoff rate, compute the net present value of this capital expenditure proposal.
Under net present value analysis, should Manchester accept the proposal?

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Year 1.... Year 2.... Year 3.... Year 4. Year 5. $ 80,000 160,000 160,000 160,000 80,000