Question

A company is considering the acquisition of production equipment which will reduce both labor and materials costs.  The cost is $100,000 and it will be depreciated on a straight-line basis down to $0.  The useful life of the equipment is five years, and it will have a $20,000 market value at the end of five years.  Operating costs will be reduced by $30,000 in the first year and the savings will increase by $5,000 per year in years 2, 3, and 4.  Due to increased maintenance costs, savings in year five will be $10,000 less than the year four savings.  The equipment will also reduce net working capital by $5,000 throughout the life of the project.  The firm’s tax rate is 35 percent and the required return is 16 percent.  Should the firm purchase this production equipment?