An automobile parts manufacturer is evaluating an investment in a new machining tool that could revolutionize its operations, cutting operating costs significantly. Operating costs would fall by $25,000 per year for 5 years. Purchase of the tool requires a $100,000 investment and the tool is in a CCA class with a rate of 10%. The tax rate for the firm is 32% and the required return on equity to the owners is now 16%.
The company is a small family-owned operation. Any debt financing that was used to establish the business was repaid more than 15 years ago. If purchased, the new tool will be financed with 75% debt and 25% equity. The debt is a loan with interest of 9% due at the end of every year. The loan requires level principal repayment over a period of 5 years, which is the estimated useful life of the new tool. It has no expected salvage value.
a) Calculate the NPV using the adjusted present value (APV) method
b) Calculate the NPV using the FTE method.