Question

Wickersham Corp. is contemplating the purchase of a machine that would improve the overall efficiency of the production process. Horton, the General Manager, believes that the new machine will:

 Increase practical capacity by 10%, enabling Wickersham to produce 100 more units each month (for which demand is available). The product sells for $10 per unit.

 Create $40,000 per year in variable operating expense savings, primarily through reduced electricity consumption and hazardous waste generation.

 Require an annual inspection by the state environmental protection board to verify compliance with permits.

Each inspection costs $5,000. The new sales will increase accounts receivable balances by $1000 in the first year only. The savings in electricity and waste disposal will decrease accounts payable 10% of the realized savings in each of the first two years. All working capital changes will reverse at the end of the project. The new machine costs $80,000 and has a $10,000 salvage value at the end of Year 3. Wickersham Corp. will pay $5,000 to transport the machine to its facility and $10,000 to install it. Training costs will total $5,000. The company uses the straight-line method of depreciation. The company believes that it can gain reputation value for its improved environmental and community reputation due to less waste and estimates that the present value of such reputation improvements is $10,000. Wickersham Corp. has a weighted average cost of capital of 15% and a marginal income tax rate of 35%.

Should Wickersham Corp. purchase the machine? Why or why not?

Answer 1

Year	Investment cashflow	Increased in sales	Savings in operating expense	Annual inspection cost	Depreciation on machine	Total net before tax cashflow	Tax@35%	Net after tax cashflow	Add back depreciation to net after tax cashflow	After tax Discount factor@ 9.75%	Present value
0	-97000								-97000	1	-97000
1	5000	12000	40000	-5000	-30000	17000	5950	11050	41050	0.911162	37403.19
2	-4000	12000	40000	-5000	-30000	17000	5950	11050	41050	0.830216	34080.35
3		12000	40000	-5000	-30000	17000	5950	11050	41050	0.756461	31052.71
3	10000								10000	0.756461	7564.608
		Net present value									13100.87
	Add :	Present value of reputation gained									10000
		Total net present value									23100.87
Wickersham Corp. should buy the machine as total net present value is postive