Manchester Company is considering a proposal to purchase special equipment at a cost of $660,000. The equipment will be
Posted: Sun Apr 17, 2022 7:02 pm
Manchester Company is considering a proposal to purchase special
equipment at a cost of $660,000. The equipment will be useful for
five years and has an expected $65,000 salvage value. Manchester
expects annual savings in cash operating expenses (before taxes) of
$235,000. For tax purposes, the annual depreciation deduction will
be as follows (salvage value is ignored on the tax return):
The income tax rate is 40%.
Manchester establishes a hurdle rate for a net present value
analysis at the company's weighted average cost of capital plus 2
percentage points. Manchester's capital is provided in the
following proportions: debt, 70%; common stock, 20%; and retained
earnings, 10%. The cost rates for these capital sources are debt,
8%; common stock, 12%; and retained earnings, 10%.
a. Compute Manchester's (1) weighted average cost of capital and
(2) hurdle rate.
Round answers to one decimal place. For example, 0.4567 =
45.7%.
b. Using Manchester's hurdle rate, compute the net present value of
this capital expenditure proposal.
Round answers to the nearest whole number. Use rounded answers for
subsequent calculations. Use a negative sign with net present value
to indicate a negative amount. Otherwise do not use negative signs
with your answers.
Under the net present value analysis, should Manchester accept the
proposal?
Select the most appropriate answer below.
Manchester should not accept the proposal, because its net
present value is positive.
Manchester should accept the proposal, because its net present
value is negative.
Manchester should accept the proposal, because its net present
value is positive.
Manchester should not accept the proposal, because its net
present value is negative.
equipment at a cost of $660,000. The equipment will be useful for
five years and has an expected $65,000 salvage value. Manchester
expects annual savings in cash operating expenses (before taxes) of
$235,000. For tax purposes, the annual depreciation deduction will
be as follows (salvage value is ignored on the tax return):
The income tax rate is 40%.
Manchester establishes a hurdle rate for a net present value
analysis at the company's weighted average cost of capital plus 2
percentage points. Manchester's capital is provided in the
following proportions: debt, 70%; common stock, 20%; and retained
earnings, 10%. The cost rates for these capital sources are debt,
8%; common stock, 12%; and retained earnings, 10%.
a. Compute Manchester's (1) weighted average cost of capital and
(2) hurdle rate.
Round answers to one decimal place. For example, 0.4567 =
45.7%.
b. Using Manchester's hurdle rate, compute the net present value of
this capital expenditure proposal.
Round answers to the nearest whole number. Use rounded answers for
subsequent calculations. Use a negative sign with net present value
to indicate a negative amount. Otherwise do not use negative signs
with your answers.
Under the net present value analysis, should Manchester accept the
proposal?
Select the most appropriate answer below.
Manchester should not accept the proposal, because its net
present value is positive.
Manchester should accept the proposal, because its net present
value is negative.
Manchester should accept the proposal, because its net present
value is positive.
Manchester should not accept the proposal, because its net
present value is negative.