You are working as an analyst for Alamo Printing. The company is considering purchasing a new $200,000 printer for oversized documents in 2010. The company would incur $10,000 in shipping costs and $15,000 in installation costs. The machinery has an economic life of 4 years and would be depreciated on the MACRS 3- year schedule (Year 1, 33.33%, Year 2, 44.45%; Year 3, 14.81%, and Year 4, 7.41%). The salvage value is estimated to be $25,000 after 4 years of use.
The new machine would allow Alamo to print 1,250 jobs of oversized documents each year for 4 years. Alamo would charge $200 per oversized document job in 2011 and would incur $100 in incremental costs per oversized document job produced in 2011.
Because of inflation, Alamo thinks that it will be able to increase the price it charges per job by 12% every year. However, you also estimate that the costs per job will increase by 12% each year.
You realize that increased production will also mean an increased need for inventory. You predict that you will need net working capital equivalent to 12% of each year’s sales revenues to support this additional printing.
The firm is in a 35% tax bracket and its cost of capital is 12%.
Your boss has asked you to analyze the project and determine whether you think the printer should be purchased. He wants you to write a memo stating whether or not the machine should be purchased and justifying your recommendation. Your memo should not be more than one page long, but you can provide additional pages of documentation to support your answer. You know that you will be eligible to be considered for a promotion at the end of the month, therefore, you want to impress your boss with your analysis and communication skills. Make sure that you thoroughly justify your recommendation, provide any information regarding assumptions that you are making, and communicate in a concise, yet thorough, manner.
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