Matthews Corp. is considering replacing its paper processing equipment. The existing equipment was purchased ten years ago for $22.50 mln. Management estimate that this equipment could be salvaged today for $2.50 mln or in another seven years for $1.15 mln. The new equipment will cost the firm $18.75 mln. Management estimate that the new equipment will last for seven years and it will be salvaged at that time for $3.25 mln. Both the new and the existing equipment have a CCA Rate of 17.50%.

Replacing the existing equipment will allow Matthews to reduce its cash outflows (i.e., costs) by $3.15 mln in its first year of operation. These savings, however, will decline by 3.00% annually over the life of the machine. The firm will also need to increase its inventory levels by $2.00 mln in order to accommodate the new equipment.

Matthews Corp. has 8,500 coupon bonds outstanding. These bonds have a coupon rate of 6.95%, paid semi-annually, and ten years to maturity. The current YTM on these bonds is 5.50%. The firm also has 500,000 shares outstanding, currently priced at $25.00 per share. The return on the companys shares has a correlation coefficient with market returns of 0.625 and a volatility of 28.95%. The firms average tax rate is 18.75% and its marginal tax rate is 22.25%.

The expected return on the S&P/TSX Composite Index is 9.75% and its volatility is 13.95%. The current Government of Canada 10-Year Benchmark Bond Yield is 2.10%.

Should Matthews Corp. replace its existing equipment?