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Question - You have been asked to evaluate the proposed purchase of a new machine by your company, Sprockets and Widgets. The price of the new machine is £250,000, and it will cost an additional £25,000 to adapt it to the company's purpose. The company might try to sell the machine after 5 years, but it is very unlikely to get a meaningful (material) price. Depreciation is based on the straight-line method. Use of the machine would require an increase in net working capital of £15,000, which would be recovered in the final year of the investment. The machine is expected to save the firm £50,000 per year in operating costs. The corporate tax rate is 40%.
Required -
a. What is the initial investment outlay associated with the machine purchase?
b. What is the terminal cash flow in year 5?
c. Critically examine the treatment of working capital in the above case.
d. If the project's required rate of return is 15%, should the equipment be purchased?
e. Undertake a detailed critical evaluation of how Sprockets and Widgets could increase the NPV of the project by using debt finance.
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