Sci Tech Case Study

To: Pressco, Inc. CFO

From: Analyst

Date: December 1, 1985

Re: New equipment purchase – paper drying machine

Background

Pressco, Inc. has the opportunity to purchase a paper drying machine at the cost of $2.9 million. The purchase will add value to the company’s operation in the estimated amount of $560,000 per year. However, a likely change in tax legislation within the next 12 months will affect the value of this purchase. With competitors moving in quickly to purchase new equipment before the new legislation, Pressco must decide if now is the time to upgrade their own equipment.

Recommendation

I recommend that Pressco, Inc. purchase the new paper drying machine immediately, regardless of expected changes in tax legislation. While presumed changes may benefit Pressco by lowering corporate tax rates, a proposed elimination of an investment tax credit would severely hurt the company’s chances of assuring adding value. Also, competitors have already begun purchasing new equipment in light of the rumored upcoming tax changes, assuring themselves a tax credit and lowering energy costs in the near term.

Assumptions

With prices of pulpwood on the decline (1) and a steadying economy (2) Pressco, Inc. will need to position itself to meet an increasing demand with steady output. New machinery will need to be purchased in order to compete with other industry leaders as well as improve their energy efficiency to lower costs. Timing of this purchase is critical. With proposed tax legislation lowering the corporate tax rate to 34% from 46%, Pressco will see an increase in cash flows with the purchase of the new equipment, given the ten year life of the machinery. Cost savings will increase $560,000 per year regardless of the government’s new regulations. An important factor from the proposed legislation in 1986 is the changes in depreciation and investment tax credits. If Congress decided to allow companies to grandfather in prior schedules, Pressco...