Pluto Corp. is considering investing in an automated manufacturing line. Installation of the line will cost $2,440,000. This amount will be paid up front. It will be depreciated using straight-line depreciation and is expected to last four years and will be fully depreciated for tax purposes. The cost savings for each year are expected to be as follows:
Year 1 - $600,000
Year 2 - $800,000
Year 3 - $800,000
Year 4 - $900,000
At the end of year 4, management expects to discontinue the manufacturing line and sell the equipment for $400,000. The equipment will be fully depreciated when sold, so the entire sales price is a taxable gain. Pluto is subject to a 20% tax rate and using a discount rate of 8% when making investment decisions.
Complete the following in a Microsoft Excel document and submit.
1. Compute the net present value. Compute the internal rate of return. Would you recommend that management invest in the equipment?
2. From a purely financial perspective, is it profitable to invest in this product?
3. Write a brief memo addressing the quantitative and qualitative items related to the investment. Be sure to include all of the stakeholders in the analysis.
4. Assume the Federal Reserve becomes alarmed about inflation and uses monetary policy to raises the discount rate to 12%. Recompute the net present value.
5. From a purely financial perspective, is it profitable to invest in this product if the discount rate is 12%?