Question

Question 1 M & M Printing is considering the purchase of a new printing press. The cost of the press is $2 million. This outlay will be partially offset by the sale of an existing press The old press has zero net book value, cost $1 million ten years ago and can be sold currently for $0.2 million before taxes. As a result of acquiring the new press, sales in each of the next five years are expected to increase by $1.6 million but product costs, excluding depreciation, will represent forty percent of sales. The new press will require that creditors be upped by four hundred thousand dollars and debtors increase by nine hundred thousand dollars. The new press will also be depreciated using a straight line method to a residual value of three hundred thousand dollars but will only fetch two hundred and twenty thousand dollars on the market. Investing in such assets attracts a Special Initial Allowance (SIA) of twenty five percent of the installed cost to be spread equally over the useful life of the asset. This new printing press is expected to chew $200 000 to install it. The firm is subject to a thirty percent tax rate on both ordinary income and capital gains. Wells Printing cost of capital is 20 percent per year. Assume that depreciation is tax allowable. Required Advice the company on whether to invest in the new press or not, using Profitability index approach.

Answer 1