Question

Question 4

ROST Corporation is a manufacturer of a variety of kitchen utensils. In order to improve the quality of existing products, the production manager of the company proposes to replace a machine used in the molding process. As a financial manager of the company, you are responsible for assessing the feasibility of this project. After a preliminary study, it is estimated that the new project will generate additional sales revenue of $310,200 in each of the next four years. It is known that the company faces a marginal tax of 26% and wants a 17% required rate of return. In addition, the company employs the straight-line method to compute its depreciation. To finance the project, the company would have to borrow $1,200,000 at 10% interest from its bank. Other findings of the study are presented as follows:

Old Machine New Machine Initial purchase price $1,120,000 $960,000 Tax life 20 years 4 years Age 16 years 0 years Expected salvage value $0 $0 Current market value $224,000 N.A. Annual cash expense $360,000 $380,000 (a)

(b)


(c)








Determine the annual after-tax cash flows associated with this project.

Determine whether you would accept or reject the project if the net present value rule is used.

Without doing any calculation, how would you reply to your boss if he told you to evaluate this project by the internal rate of return rule rather than the net present value rule? (word limit: 150 words)

Answer 1

Solution