Ferris Company is considering investing in new equipments that would cost $80,000 and have a 5-year useful life and zero salvage value. Expected changes in annual revenues and expenses if the new machine is purchased are as follows:
Details Amount Amount
Increased Revenue $63,000
Salary of additional Operator $10,000
Maintenance $3,600 $38,600
Increased Income (Pre-Tax) $24,400
Taxes (40%) $9,760
Increased Operating Income $14,640
The company has a debt to equity ratio of 300% ($3 of debt for every $1 of equity). The pre-tax cost of debt is 10% and the cost of equity is 18%.
a. Compute the accounting rate of return, rounded to 2 decimal places.
b. Compute the cash flow generated per year for years 1-5.
c. Compute the weighted average cost of capital.
d. How many years will it take for the project to “pay for itself.”.
e. Compute the NPV (Note: Formulas for the PV factors are pre-coded in the excel file, but you will need to input the discount rate).
f. Compute the IRR.
g. Without calculating exact numbers, indicate whether and how the following measures would change if the company shifted its financing structure to be more heavily weighted toward equity than debt.
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