Question: A firm is considering a $120,000 outlay for a new piece of equipment which is expected to increase employee productivity. Over its 5-year life, this equipment is expected to reduce current annual operating costs of $2.4M by 2%. The equipment is not expected to have any effect on revenue or other costs. The equipment will be depreciated on a straight line basis with $10,000 in salvage value. The treasury bill rate is 4%, the market risk premium is 4% and the firm's beta is 1.5. Assume corporate tax rate is 30%.
a) Calculate the annual after-tax operating cash flows for each of the next five years associated with the purchase of this piece of equipment.
b) Compute the NPV, profitability index and payback period for this project. Do you think the company should pursue the project? Why or why not?
c) If the project's IRR was 13%, would it represent an attractive project? Why or why not? What about 7%?