Capital Budgeting

Currently, Global Manufacturing Corporation is considering replacing a 5-year-old machine that originally cost $300,000, and has been being depreciated as a 7-year MACRS asset over the last five years.The old machine is being operated at capacity and is subject to frequent breakdowns. The maximum capacity for the old machine is 100,000 units per year. The old machine uses a full-time operator at $45,000 each per year.Cost of maintenance per year is $15,000. Currently the old machine could be sold for $80,000.If Global does not replace this machine and is willing to incur the high maintenance costs, they could continue to use it indefinitely.

Each unit produced on the old machine currently sells for $20 and has direct costs of $8. Both prices and direct costs are subject to inflation, currently at 3%.The sales and marketing department estimates the company sales could grow by 5 to 9 percent a year if they had the capacity for production.

The company is looking at two possible replacement machines:one produced by Dearborne Machine Tools and one produced by Kinnikut Machine Tools.

The Dearborne Machine Tools machine is a radically new model and would cost $375,000 and, in addition, there would be $10,000 shipping costs.Further, the existing space would have to be remodeled to accommodate the machine at a cost of $35,000. The Dearborne machine would be of use to the company over the 7-year life of the project. It would be depreciated using MACRS (7 year asset).At termination of the project in 7 years, the machine would have an estimated salvage value of $55,000.The maximum capacity of the new machine is 150,000 units per year.Maintenance would be performed by Dearborne under a $10,000-per-year maintenance contract. The machine would require an engineer at a salary cost of$60,000 per year.The engineer would have to go through initial training on-site at an after tax cost of $5,000 (pre-tax) to be ready to run the Dearborne machine.

The Kinnikut Machine Tools machine is a new and improved model of the company's existing machine.It has a maximum capacity of 130,000 units.Because it is similar to the machine the company is currently using, it will not entail staff training to use.Its cost is $350,000fully installed.It will be depreciated as a MACRS 7 year asset but will only be used for the seven year life of the project.At termination in 7 years, it would have a salvage value of $25,000. Maintenance on the new model is estimated at $5,000 per year.The new model will require a full-time operator at $45,000 per year.

Because of the larger capacity of both machines, additional investment in working capital would be required.Working capital needed is 10% of the coming years cost of goods. All working capital invested could be recaptured when no longer needed.

The company is in a 34% average and a 39% marginal tax rate. This is a replacement project, so the company believes the appropriate discount rate would be the WACC of 11%.

Instructions

Attached are the instructions to your group capital budgeting assignment.You are to analyze the proposal and make a recommendation to the company regarding the proposal.You will probably want to do sensitivity testing on some of the input assumptions and let those results inform your conclusions.

Prepare an excel file, PowerPoint presentation and short written recommendation.