A risk manager is considering the installation of new safety guards for the machines in the stamping process. The guards have an expected lifetime of 8 years and cost $250,000 to install. The presence of the guards have 3 negative effects: they increase annual maintenance costs by $5200 a year for the first 6 years and by $6000 a year for the last 2 years (because the machines are more difficult to service) and they increase production cost by $11,000 a year (because workers produce less output once the guards are installed). Both these expenses are realized at year end. Finally there is a training cost of $1000 a year at the beginning of the year to ensure that workers

Each year of their life, the guards are expected to reduce the employer’s retained work-injury costs and expenses related to employees injuring themselves on the production line by $10,000. These savings are realised at the end of each year. In addition the employer’s worker’s compensation insurance is willing to reduce the premium for coverage by $44,000 a year (payable at the beginning of the year) if the guards are installed. The employer faces a 34% tax rate on income and straight-line depreciation is used for the safety guards.

1. Calculate the annual after tax cash flows from installing the ventilating equipment.
2. If the firm’s cost of capital is 9%, should it install the safety guards?
3. Will the installation of the safety guards affect the firm’s cost of capital? Why or why not?

Answer rating: 100% (QA)

To calculate the annual aftertax cash flows from installing the safety guards we need to consider th... View the full answer