Products, Inc. manufactures a product it sells for $25. Adams sells all of the
24,000 units per year it is capable of producing at the current time, and a
marketing study indicates that it could sell 14,000 more units per year. To
increase its capacity, Adams must buy a machine that has the capacity to
produce 50,000 units of its product annually. The existing equipment can
produce the product at a unit cost of $16. Today it has a book value of $80,000
and a market value of $60,000. The new equipment could produce 50,000 units at
a unit cost of $12. The new equipment would cost $500,000 and would be
depreciated uniformly over its five-year life. If the new machine is purchased,
fixed operating costs will decrease by $20,000 per year.
-If Adams’s cost of capital is 18
percent and its tax rate is 30 percent, should Adams buy the new machine? Why?