National Parts, Inc., an auto parts manufacturer, is considering purchasing a rapid prototyping system to reduce prototyping time for form, fit, and function applicationsin automobile parts manufacturing. An outside consultant has been called in to estimate the initial hardware requirement and installation costs. He suggests the following:
• Prototyping equipment: $187,000.
• Posturing apparatus: $10,000.
• Software: $15,000.
• Maintenance: $36,000 per year by the equipment manufacturer.
• Resin: Annual liquid polymer consumption of 400 gallons at $350 per gallon.
• Site preparation: Some facility changes are required for the installation of the rapid prototyping system (e.g., certain liquid resins contain a toxic substance, so the work area must be well vented).
The expected life of the system is six years, with an estimated salvage value of $30,000. The proposed system is classified as a five year MACRS property. A group of computer consultants must be hired to develop customized software to run on the system. Software development costs will be $20,000 and can be expensed during the first tax year. The new system will reduce prototype development time by 75% and material waste (resin) by 25%. This reduction in development time and material waste will save the firm $114,000 and $35,000annually, respectively. The firm’s expected marginal tax rate over the next six years will be 40%. The firm’s interest rate is 20%.
(a) Assuming that the entire initial investment will be financed from the firm’sretained earnings (equity financing), determine the after tax cash flows over the life of the investment. Compute the NPW of this investment.
(b) Assuming that the entire initial investment will be financed through a localbank at an interest rate of 13% compounded annually, determine the net after tax cash flows for the project. Compute the NPW of the investment.
(c) Suppose that a financial lease is available for the prototype system at $62,560 per year, payable at the beginning of each year. Compute the NPW of the investment with lease financing.
(d) Select the best financing option, based on the rate of return on incremental investment.