Question

Wells Printing is considering the purchase of a new printing press. The total installed cost of the press is $2.2 million. This outlay would be partially offset by the sale of an existing press. The old press has zero book value, cost $1 million 10 years ago, and can be sold currently for $1.2 million before taxes. As a result of acquisition of the new press, sales in each of the next 5 years are expected to be $1.6 million higher than with the existing press, but product costs (excluding depreciation) will represent 50% of sales. The new press will not affect the firm’s net working capital requirements. The new press will be depreciated under MACRS, using a 5-year recovery period. The firm is subject to a 40% tax rate. Wells Printing’s cost of capital is 11%. (Note: Assume that the old and the new presses will each have a terminal value of $0 at the end of year 6.) [15 marks]
i. Determine the initial investment required by the new press. [2 marks]
ii. Determine the operating cash flows attributable to the new press. (Note: Be sure to consider the depreciation in year 6.) [6 marks]
iii. Determine the payback period. [2 marks]
iv. Determine the net present value (NPV) and the internal rate of return (IRR) related to the proposed new press. [4 marks]
v. Make a recommendation to accept or reject the new press, and justify your answer. [1 marks]

Answer 1