Madison Manufacturing is considering a new machine that costs
Madison Manufacturing is considering a new machine that costs $350,000 and would reduce pre-tax manufacturing costs by $110,000 annually. Madison would use the 3-year MACRS method to depreciate the machine, and management thinks the machine would have a value of $33,000 at the end of its 5-year operating life. The applicable depreciation rates are 33.33%, 44.45%, 14.81%, and 7.42%, as discussed in Appendix 11A. Working capital would increase by $35,000 initially, but it would be recovered at the end of the project’s 5-year life. Madison’s marginal tax rate is 40%, and a 10% WACC is appropriate for the project.
a. Calculate the project’s NPV, IRR, MIRR, and payback.
b. Assume management is unsure about the $110,000 cost savings—this figure could deviate by as much as plus or minus 20%. What would the NPV be under each of these extremes?
c. Suppose the CFO wants you to do a scenario analysis with different values for the cost savings, the machine’s salvage value, and the working capital (WC) requirement. She asks you to use the following probabilities and values in the scenario analysis:
|
Scenario |
Probability |
Cost Savings |
Salvage Value |
WC |
|
Worst case |
0.35 |
$88,000 |
$28,000 |
$40,000 |
|
Base case |
0.35 |
110,000 |
33,000 |
35,000 |
|
Best case |
0.30 |
132,000 |
38,000 |
30,000 |
Calculate the project ’ s expected NPV, its standard deviation, and its coefficient of variation. Would you recommend that the project be accepted?
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Rating:
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Solution: Madison Manufacturing is considering a new machine that costs