Seco Dame Enterprises (SDE) acquired a robotic saw six years ago at a cost of $10 million. The saw was depreciated under the old ACRS rules to its current book value of $0. Actual salvage value today is estimated to be $2 million. SDE's average tax rate is 30 percent, and its marginal tax rate is 40 percent. The weighted cost of capital for SDE is 15 percent.
A new robotic saw will cost $15 million. It will be depreciated under MACRS rules for a 7-year class asset. If SDE acquires the new saw, it estimates that its net working capital investment will decline, due to the reduced need to carry inventories of spare parts for this more reliable machine. Net working capital should decline from a current level of $1 million to a new level of $500,000 as a result of this purchase.
a. Calculate the net investment required to acquire the new saw.
b. The new saw is expected to reduce operating costs (exclusive of depreciation) for SDE by $800,000 per year over the asset's expected 10-year life. Also, the increased productivity of the new saw is expected to increase SDE's revenue by $2 million per year. Salvage value at the end of 10 years is expected to be $0. Calculate the annual net cash flows for this investment.
c. Compute the NPV for this project.