Question

A new industrial press will cost Pop’s Metal Fabrication Shop $120,000 and will have a useful lifespan of 10 years. At that point (in 10 years) the press will have a salvage value of $0. The upside of this investment is that Pop will save an estimated $2,331 per year in production costs - prior to factoring in taxes and depreciation. The company always depreciates assets in a straight-line basis and has a marginal tax rate of 25%. The firm’s cost of capital is 12%. Based on the IRR criterion, is this a smart purchase for Pop? Explain why or why not and justify your answer analytically.

Answer 1

Years	Capital Expenses	Cost Saving	Depreciation	Income Before Tax	Tax Saving	Income After Tax	Depreciation	Cashflows
0	$            (120,000.00)							$   (120,000.00)
1		$     2,331.00	$       12,000.00	$                    (9,669.00)	$   2,417.25	$               (7,251.75)	$                                                 12,000.00	$          4,748.25
2		$     2,331.00	$       12,000.00	$                    (9,669.00)	$   2,417.25	$               (7,251.75)	$                                                 12,000.00	$          4,748.25
3		$     2,331.00	$       12,000.00	$                    (9,669.00)	$   2,417.25	$               (7,251.75)	$                                                 12,000.00	$          4,748.25
4		$     2,331.00	$       12,000.00	$                    (9,669.00)	$   2,417.25	$               (7,251.75)	$                                                 12,000.00	$          4,748.25
5		$     2,331.00	$       12,000.00	$                    (9,669.00)	$   2,417.25	$               (7,251.75)	$                                                 12,000.00	$          4,748.25
6		$     2,331.00	$       12,000.00	$                    (9,669.00)	$   2,417.25	$               (7,251.75)	$                                                 12,000.00	$          4,748.25
7		$     2,331.00	$       12,000.00	$                    (9,669.00)	$   2,417.25	$               (7,251.75)	$                                                 12,000.00	$          4,748.25
8		$     2,331.00	$       12,000.00	$                    (9,669.00)	$   2,417.25	$               (7,251.75)	$                                                 12,000.00	$          4,748.25
9		$     2,331.00	$       12,000.00	$                    (9,669.00)	$   2,417.25	$               (7,251.75)	$                                                 12,000.00	$          4,748.25
10		$     2,331.00	$       12,000.00	$                    (9,669.00)	$   2,417.25	$               (7,251.75)	$                                                 12,000.00	$          4,748.25
							IRR	-14.07%
							IRR is less than WACC
							Project Should not be accepted