Question: QUESTION 4: Pickering Manufacturing Limited (PML) is considering purchasing a widget maker. The widget makerwill result in before tax cost savings of $400,000 per year

QUESTION 4:

Pickering Manufacturing Limited (PML) is considering purchasing a widget maker. The widget makerwill result in before tax cost savings of $400,000 per year for 15 years. Assume CCA rate of 25%. After 15 years of use salvage value of the widget maker will be 0. Asset pool will remain open. The widget maker will not add/reduce the risk of the firm. Cost of unlevered equity is 10%, corporate tax rate is 40%, and risk free rate of return is 3%. Hint: Use risk free rate to discount CCATS.

a.What is the maximum price PML should pay for the machine?

b.Suppose due to economic conditions Ontario government is willing to lend PML $2,000,000 at 2%. This loan will be amortized over 4 years in 4 equal installments (principal repayment + interest). Using APV approach, what is the maximum price PML would be willing to pay for the widget makerif PMLs cost of debt is 8%?

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