BA350 Financial Management: 12-13 Holmes Manufacturing is considering a new machine

BA350 Financial Management

Holmes Manufacturing is considering a new machine that costs $250,000 and would reduce pretax manufacturing costs by $90,000 annually. Holmes would use the 3-year MACRS method to depreciate the machine, and management thinks the machine would have a value of $23,000 at the end of its 5-year operating life. The applicable depreciation rates are 33%, 45%, 15%, and 7% as discussed in Appendix 12A. Net operating working capital would increase by $25,000 initially, but it would be recovered at the end of the project’s 5-year life. Holmes’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 $90,000 cost savings – this figure could deviate by as much as plus or minus 20%. What would the NPV be under each of these situations?
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 net operating working capital (NOWC) requirement. She asks you to use the following probabilities and values in the scenario analysis.
Scenario Probability Cost Savings Salvage Value
Worst Case 35% 72,000 18,000
Base Case 35% 90,000 23,000
Best Case 30% 108,000 28,000

Calculate the project’s expected NPV, its standard deviation, and its coefficient of variation.
Would you recommend that the project be accepted? Why or why not?
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