The current date is 12/31/00. The Stopwhining Corporation has decided that manufacturing voting machines will become a boom business. It has access to two designs. The first involves punching holes in cards. If produced the machine will be Dimple-free. Some people believe this technology is superior as it allows hand recounts of votes. The second type of machine is a fully automatic electronic machine. Some people believe that this technology is superior because it is error free so no recounts will ever be necessary. These machines will be called Right-way if produced.
The plant to produce Dimple-free machines will cost $10 million to purchase. It will be ready for production on 1/1/01. It will manufacture 10,000 machines in the first and second years after purchase. These can all be sold for $1000 per machine. At the end of the second year the plant will cease production. It will have a salvage value of $2 million. The raw material and labor costs together are $300 per machine.
The plant to produce Right-Way machines will cost $8 million to purchase. It will be ready for production on 1/1/01. It will manufacture 7,742 machines in the first and second years after the purchase. These can all be sold for $1,200 per machine. At the end of the second year the plant will cease production. It will have a salvage value of $1 million. The raw material and labor costs together are $400 per machine.
All figures are given in nominal terms. The firm has a corporate tax rate of 35 percent and uses straight line depreciation. The nominal opportunity cost of capital for this type of project is 12 percent. The nominal debt rate is 6 percent.
Assume all cash flows occur at year’s end and that the firm has profitable ongoing operations.
(a) Give a table of cash flows with one column for each year’s end for the plant to produce Dimple-free and the plant to produce Right-way.
(b) Calculate the base-case NPV of each plant at 12/31/00 assuming each is all equity financed.
(c) Calculate the APV of each plant at 12/31/00 assuming that in every year the optimal debt capacity of the firm is increased by 30 percent of the project’s base-case PV and this is the only financing side effect.