Madison Manufacturing is considering a new machine that costs $350,000 and would reduce pre-tax manufacturing costs by $110,000 annually. Madison 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 depreciation rates are 33.33%, 44.45%, 14.81%, and 7.42%. Working capital would increase by $35,000 initially, but it would be recovered at the end of Year 5. Madison’s tax rate is 40%, and its WACC is 10%.
a) Calculate the project’s NPV, IRR, MIRR, and payback.
b) Management is unsure about the $110,000 cost savings—it could be plus or minus 20%. What would be the NPVs under each extreme?
c) Suppose the CFO wants you to do a scenario analysis with different values of the cost savings, the machine’s salvage value, and the working capital requirement. She gives you the following table:
Scenario Probability Cost Savings Salvage Value Working Capital
Worst case 0.35 $88,000 $28,000 $40,000
Base case 0.35 110,000 33,000 35,000
Best case 0.30 132,000 38,000 30,000
Calculate the project’s expected NPV, its standard deviation, and its coefficient of variation. Would you recommend that the project be accepted?