A U.S. manufacturer of particleboard furniture is considering investing in a new
ID: 1093101 • Letter: A
Question
A U.S. manufacturer of particleboard furniture is considering investing in a new stamping machine. The machine is expected to have a useful life of five years, after which the machine can be sold as scrap for as estimated 5000. The firm plans to issue bonds to pay for the machine and intends to treat the interest rate on the bonds as the relevant discount rate for evaluating the project. The machine will cost the firm 175,000, all of which must be paid at the beginning of the project. The new stamping machine will reduce production costs by 50,000 per year, for each year of the machine's life. The firm treats all of the cost savings as if they occur at the end of each year.
Should the firm plan to undertake the investment projectm bonds will be issued in approximately 3 months. The firm has estimated the supply and demand for loanable funds as:
LD = 25,000,000 - 125,000,000r
LS= 2,500,000 + 62,500,000r
where LD is the demand for loanable funds, LS is the supply of loanable funds, and r is the interest rate.
a. Given the information above, should the firm undertake the investment in the stamping machine ?
b. Assume that the demand for loanable funds shifts upward 3,750,000 (i.e. 3,750,000 more demand at every interest rate). What impact will this increase in demand have on the interest rate and on the firm's stamping machine project ? Assume the firm learns of the change in demand before accepting the project.
Explanation / Answer
inorder for the firm to pay for machine
LD - LS >= 175000
25000000 - 125000000r = 2.500000 + 62500000r + 175000
r = 11.91%
for machine
Net Present Value
NPV = -175000 + 50000/1.1191 + 50000/1.1191^2 + 50000/1.1191^3 + 50000/1.1191^4 + 50000/1.1191^5 + 5000/1.1191^5
= 8489.95
Since NPV is positive, the firm should undertake the project
b)
with increse in demand interest will change
LD - LS >= 175000
25000000 - 125000000r + 3750000r= 2.500000 + 62500000r + 175000
r = 12.15%
NPV = -175000 + 50000/1.1215 + 50000/1.1215^2 + 50000/1.1215^3 + 50000/1.1215^4 + 50000/1.1215^5 + 5000/1.1215^5
= 7389.26
NPV is postive the firm should accept project
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