Hill Ltd. is considering updating its systems, which will cost $100,000. The new system will be depreciated prime cost to zero over its 5-year life. It will probably be worth about $20,000 after 5 years.

The new machine will save $20,000 per year in operating costs. The tax rate is 30 percent, and the tax is paid in the year of income.

Hill Ltd. has several classes of outstanding bonds, and the average yield is 6%. Its beta is 1.3, the historical market risk premium is 7.94%, and the treasury yield is 4%.

Question a:

If Hills capital structure is 40% debt and 60% equity, what is Hills cost of capital (WACC Weighted Average Cost of Capital)? Explain your answer.

Question b:

Should Hill Ltd purchase the new system? Show your analysis using the capital budgeting techniques and explain your answer.