Final answer:
The CEO of Soda Wins Coke Inc. is making a capital budgeting decision involving the analysis of additional sales, costs, depreciation, taxes, and cash flows to evaluate the purchase of new machines.
Step-by-step explanation:
The evaluation of the purchase of new machines by Soda Wins Coke Inc. involves a capital budgeting decision which considers the initial investment of $12.5 million, additional sales, variable costs, straight-line depreciation, and the impact of the corporate tax rate. To analyze this investment, we must calculate the project's net present value (NPV) or internal rate of return (IRR) by forecasting the incremental cash flows over the 7-year life of the machines.
Assuming no salvage value, the annual depreciation expense would be $12.5 million / 7 years = $1.785 million. The additional sales of 3,450,000 bottles at $3 per bottle will result in incremental revenues of $10.35 million annually. Subtracting the variable cost of $1 per bottle, total variable costs will be $3.45 million annually. The annual incremental profit before tax and depreciation is therefore $10.35 million - $3.45 million - $1.785 million = $5.115 million. Taking into account the tax shield from depreciation and the corporate tax rate, the after-tax incremental profit can be calculated, and the free cash flows derived, which will be discounted back to present value using the firm's cost of capital.
It's important to also consider any additional working capital requirements and the project's residual value, if any, at the end of its useful life. These factors can significantly affect the project's viability and the final investment decision.