MMG Manufacturing is considering a new machine that costs $300,000 and would reduce pretax manufacturing costs by $92,000 annually. Holmes would use the 3-year MACRS method to depreciate the machine, and management thinks the machine would have a value of $33,000 at the end of its 5-year operating life. The applicable depreciation rates are 33%, 45%, 15%, and 7%. Net operating working capital would increase by $30,000 initially, but it would be recovered at the end of the project’s 5-year life. Holmes’s marginal tax rate is 35%, and a 11.0% WACC is appropriate for the project.
a. Calculate the project’s NPV, IRR , and MIRR
b. Assume management is unsure about the $92,000 cost savings — this figure could deviate by as much as plus or minus 20%.
What would the NPV be under each of these situations?
Situation1 (cost saving increase by 20%):
Situation2 (Cost savings decrease by 20%):
Suppose the CFO wants you to do a scenario analysis with different values for the cost savings, the machine’s salvage value, and the net operating working capital (NOWC) requirement. She asks you to use the following probabilities and values in the scenario analysis:
Scenario Probability Cost Savings Salvage Value NOWC
Worst Case 0.25 $70,000 $26,000 $32,000
Base Case 0.50 $92,000 $33,000 $30,000
Best Case 0.25 $110,000 $40,000 $28,000
c. Calculate the project’s expected NPV, its standard deviation, and its coefficient of variation
d. Would you recommend that the project be accepted?
Hint to question a. Please calculate the cash flows from the table below (90% of the answer is already provided to you), in order to be able to calculate NPV, IRR, MIRR, and payback period