New Horizons Co.’s products are in high demand these days; as such, the firm wants to purchase a new machine to boost its productivity. After spending $45,000 on marketing research, New Horizons’ CFO believes that buying the new machine will increase the firm’s sales by 1 million dollars per year, and cost of goods sold by $0.2 million per year. Because of the new machine, New Horizons’ net working capital is expected to be $100,000 higher throughout the life of the new machine. New Horizons currently has enough workers to operate the new machine; however, some of the less skilled workers need further training which will cost the firm approximately $50,000. Of course, the training can only start when the new machine is in place.

The new machine has a price of 2 million dollars and falls into a MACRS ADS 3-year class; thus, it should be depreciated at 33.33%, 44.45%, 14.81% and 7.41% in years 1 through 4, respectively. The machine has an expected life of 4 years; after that, the manufacturer of the machine offers to recycle it for free. The new machine will occupy a small room which is currently used as a storage room; as a result, New Horizons will need to rent a new storage room for $20,000 a year (after-tax).

New Horizons currently faces a 35% tax rate. The firm has common shares and bonds only, and the firm’s capital structure is described in Table 2 below.

Table 2. New Horizons’ Debt and Equity

Equity:
Number of shares outstanding	10,000,000
Stock price	$5.50
Cost of equity	12%
Debt:
Number of bonds issued	50,000
Par value	$1,000
Years left until maturity	20
Coupon rate	7% per year, semi-annual coupons
Current bond price	$900

1. Please complete the table below to calculate financial cash flows.

Hint: In this case, ∆EBIT = ∆Sales - ∆Cost of Goods Sold - Depreciation

Year 0	Year 1	Year 2	Year 3	Year 4
∆EBIT
Minus: Taxes
Depreciation
Minus: ∆NWC
Capital Investment
Other
Financial Cash Flow

2. Use Table 2 to calculate New Horizons’ WACC. Should New Horizons go ahead to buy the new machine? Why?
3. If the CFO wants a minimum return of 15%, should the new machine be purchased?

Answer rating: 100% (QA)

a Calculation is as follows Formulas b To calculate cost of debt we need to calculate the ... View the full answer