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An auto garage is considering getting in the auto rental business. It is considering purchasing 100 new automobiles at a total cost of $2,000,000. The automobiles will be depreciated as 5-year property under the MACRS method of depreciation (Year 1 - 20%, Year 2 - 32%). However the firm plans on selling the new cars for 60 percent of their original cost after two years.
It is estimated that the purchase would increase revenues by $900,000 the first year and by $1,000,000 in the second year. Additional operating costs due to the purchase are estimated at $150,000 in year one and $250,000 in year two. It also estimated that net working capital will have to be increased by about $50,000 if the cars are purchased. Additionally, the firm expects that $100,000 in sales revenues will be lost from the garage business each year due to time spent by the mechanics on maintaining the rental cars (the garage will have to turn away business it otherwise would have accepted because the mechanics can't work on customers’ cars due to time constraints).
The firm’s tax rate is 30 percent, and the required rate of return on the project is 12 percent. Should the firm purchase the additional automobiles?
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