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Heller Inc. is considering purchasing a new machine to replace the existing machine. The existing machine was purchase three years ago for 50,000. It was being depreciated straight-line to a zero-salvage value assuming a five-year useful life. Assume the asset could be sold today for $5,000 if it is replaced. The new machine will result in increase in sales of 40,000 units per year for the next FIVE years. These units will sell for $10’unit and have a variable cost of SS per unit. The now machine will require a $300,000 investment which will be depreciated on a straight-line basis over the SIX-year life to an accounting salvage value of $0. They will not be able to sell the new machine for anything (ie, market value is SO) at the end of the project (year FIVE). Assume this project will be able to reduce net working capital initially by $50,000 (in year 0), then in the fifth year, the NWC will revert to the amount it was before the start of the project. Assume Heller is all-equity financed. There is a risk-free rate of 3% and a market risk premium of 7%. Heller has a beta of 1.2. If Heller has a 30% tax rate should they replace the old machine? Should you replace the existing machine? Use NPV calculations to support your answer.


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