Speech

PROBLEM/ISSUES

Paperco., Inc. has been in the midst of an important financial decision on whether to purchase new drying equipment or stay with its current operating methods. It was faced with this same decision a year ago, but new rumored legislation has enhanced the attractiveness of a contract with Pressco, Inc.’s equipment. The new tax legislation, if passed, will have a direct impact on how Paperco would budget for the equipment.

The proposed legislation will first eliminate the investment tax credit for new equipment, which would not be beneficial for the company, since tax credits allow it more in cost savings each year. It also will extend depreciation life for new equipment. This is appealing since the cash flows each year will be lower, but there is a less of a tax shield for the company. If extending the depreciation life is a positive or negative effect depends on which part the company is more concerned with for the future. The company will also recapture its cost of the equipment slower with the new legislation. Lastly, the corporate tax rate will decrease from 46% to 34%. The cost savings will be taxed lower for Paperco, but the tax shield will decrease, just as the depreciation life extension.

The most pertinent conclusion that Pressco must come to is to decide when the best time to have Paperco sign a contract for the equipment. Whether Paperco should enter into a contract before the proposed legislation, after, or should the legislation not pass depends on the NPV values analyzed. NPV is calculated for this company because it shows the additional value to shareholders from the purchase of this equipment. If the NPV is positive for Paperco for any of the scenarios, that scenario will be ideal because it pays back the company for the investment and generates a higher return to add to shareholder wealth. Should the analysis give an NPV of 0, it would be in Paperco’s best interest to forgo the purchase of equipment for the time...