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 , and the net operating working capital (NOWC) requirement. She asks you to use the following probabilities and values in the scenario analysis:
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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