Jack Garrett, a manager of the plate division for the Marble Top Manufacturing Company, has the opportunity to expand the division by investing in additional machinery costing $420,000. He would depreciate the equipment using the straight-line method, and expects it to have no residual value. It has a useful life of seven years. The firm mandates a required after-tax rate of return of 14% on investments. Jack estimates annual net cash inflows for this investment of $125,000 before taxes, and an investment in working capital of $2,500. Tax rate is 35%.
1. Calculate the net present value of this investment.
2. Calculate the accrual accounting rate of return on initial investment for this project.
3. Should Jack accept the project? Will Jack accept the project if his bonus depends on achieving an accrual accounting rate of return of 14%? How can this conflict be resolved?
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