The Catseye Marble Co. is thinking of replacing a manual production process with a machine. The manual process requires three relatively unskilled workers and a supervisor. Each worker makes $17,500 a year and the supervisor earns $24,500. The new machine can be run with only one skilled operator who will earn $41,000. Payroll taxes and fringe benefits are an additional third of all wages and salaries.

The machine costs $150,000 and has a tax depreciation life of five years. Catseye elects straight line depreciation for tax purposes. A service contract covers all maintenance for $5,000 a year. The machine is expected to last six years, at which time it will have no salvage value. The machine’s output will be virtually indistinguishable from that of the manual process in both quality and quantity. There are no other operating differences between the manual and the machine processes. Catseye’s marginal tax rate is 35%, and its cost of capital is 10%.

a. Calculate the incremental cash flows associated with the project to acquire the machine.

b. Calculate the project’s payback and NPV. Would you accept or reject the project?

c. Suppose there is no alternative but to lay off the displaced employees, and the cost of severance is about three months’ wages. How would you factor this information into the analysis? Does it change the project’s acceptability?

d. How would you characterize this project’s risk?