Consider adding a new line to a product mix, and the capital budgeting in the line would be set up in unused space in the main plant. The machinery’s invoice price would be approximately $200,000, another 10,000 in shipping charges would be required, and it would cost an additional $30,000 to install the equipment. The machinery has an economic life of 4 years, and Shrieves has obtained a special tax ruling that places the equipment in the MACRS 3 year class. The machinery is expected to have a salvage of $25,000 after 4 years of use. The new line would generate incremental sales of 1,250 units per year for 4 years at an incremental cost of $100 per unit in the first year, excluding depreciation. Each unit can be sold for $200 in the first year. The sales price and cost are both expected to increase by 3% per year due to inflation. Further, to handle the new line, the firm’s net working capital would have to increase by an amount equal to 12% of sales revenues. The firm’s tax rate is 40%, and its overall weighted average cost of capital, which is the risk-adjusted cost of capital for an average project (r), is 10%. Suppose the firm spent $100,000 last year to rehabilitate the production line site, should this be included in the analysis? Explain. Now assume the plant space could be leased out to another firm at $25,000 per year. should this be included in the analysis? Explain
