Adams Products, Inc., manufactures a product it sells for $25. Adams sells all of the 24,000 units per year it is capable of producing at the current time, and a marketing study indicates that it could sell 14,000 more units per year. To increase its capacity, Adams must buy a machine that has the capacity to produce 50,000 units of its product annually. The existing equipment can produce the product at a unit cost of $16. Today it has a book value of $80,000 and a market value of $60,000. The new equipment could produce 50,000 units at a unit cost of $12. The new equipment would cost $500,000 and would be depreciated uniformly over its five-year life. If the new machine is purchased, fixed operating costs will decrease by $20,000 per year.
If Adams’s cost of capital is 18 percent and its tax rate is 30 percent, should Adams buy the new machine? Why?
Howard Corporation’s sales for the year are expected to be $1,500,000 and operating expenses were $600,000. Included in the operating expenses is $100,000 of depreciation expense. If Howard’s tax rate is 30 percent, what are its projected after-tax cash flows?
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