Sawdust Ltd. needs to purchase a new machine. It has narrowed its options to two models: the
Question:
Sawdust Ltd. needs to purchase a new machine. It has narrowed its options to two models: the Dust Grinder and the Saw Mill. Both machines have useful lives of five (5) years. Purchase of these machines would result in the following net after-tax cash flows:
Year
| Dust Grinder
$
| Saw Mill
|
0
| 320 000
| 360 000
|
1
| 176 000
| 260 000
|
2
| 136 000
| 120 000
|
3
| 60 000
| 4 000
|
4
| 56 000
| 20 000
|
The firm's target capital structure is 40% debt, 10% preferred stock and 50% equity.
The after-tax cost of debt is 6%, of preferred stock, 12.5% and common equity has a cost of 15.5%
Required
(a)Compute the cost of capital
(b)Use the NPV method to identify which machine thecompany should purchase.
(c)When the cash flows of the machines are discounted at 18%, their NPVs are:
Dust Grinder -$2 760
Saw Mill - $36 804
(d)Compute the IRR for each machine
(e)Based on your conclusions in b and c above, whichmachine should the firm purchase? Explain your decision
Management Accounting
ISBN: 9781760421144
7th Edition
Authors: Kim Langfield Smith, Helen Thorne, David Alan Smith, Ronald W. Hilton