Collusion Brewery has been in business for four years and, during that time, it has shown steady
Question:
Collusion Brewery has been in business for four years and, during that time, it has shown steady growth and profitability in its regional market. Obtaining financing has always been difficult, which is particularly challenging for a capital-intensive operation. Lenders emphasize a crowded market and uncertain demand when considering and often reject funding for micro-breweries.
Collusion hired a consultant to examine the potential automation of its bottling operations. The consultant has proposed the purchase of a new automated bottling machine from Germany. The purchase price of the machine is $265,000. The machine has a 4-year useful life, with a salvage value of $25,000. The company uses straight-line depreciation for all of its assets.
The company’s attorney quoted a fee of $25,000 to review the purchase agreement and warranties and manage the international logistics of the transaction. The purchase would involve $10,000 in duties, taxes, and shipping fees.
The consultant calculates that the new machine would generate an additional $210,000 in cash revenues per year. Annual cash costs would increase by a net amount of $110,000, after factoring in the savings in payroll. The company’s tax rate is 35%, and it uses a required rate of return equal to 6% for investment opportunities.
1. Assume that “investment” is defined as net book value. Compute the machine’s ROI for each of its first four years.
2. Measure the purchase using net present value considerations on an after-tax basis.
3. What factors should management consider in evaluating the purchase? Should the company purchase the bottling machine?
