QUESTION
The J. F. Manning Metal Company is considering the purchase of a new milling machine during year zero. The machine’s base price is €P, and it will cost another 12% €P to modify the machine for special use by the company, resulting in a 112%€P cost base for depreciation. The cost base will be financed by a 60% loan of the cost-base from a commercial bank for five-years at an interest rate of 4% remaining constant over the loan life. The rest will be financed by company’s own funds. The machine falls into the ten-year straight-line method with a zero-salvage value at year ten. The machine can be sold after five years at 35%€P (actual euros). Use of the machine will require an increase in working capital (inventory) of 6% €P at the beginning of the project year. The machine will have no effect on revenues, but it is expected to save the company 60%€P (today’s euros) per year in before-tax operating costs — mainly labour. The company’s marginal tax rate is 23%, and this rate is expected to remain unchanged over the project’s duration. However, the company expects that the labour cost will increase at an annual rate of L% and that the working capital requirement will grow at an annual rate of C% caused by inflation. The general inflation rate (f) is estimated to be 6% per year over the project period. The company’s MARR is 20% (Market interest rate).
a. What are the depreciation allowances of this project?
b. What is the gains tax (if any) for this project?
c. Develop the loan schedule of this project.
d. Determine the project cash flows in actual euros.
e. Is this project acceptable?
f. What is the project’s IRR?
