Dolphin Plastics is considering replacing molding equipment used to make party c
ID: 2616229 • Letter: D
Question
Dolphin Plastics is considering replacing molding equipment used to make party cups. The current equipment was purchased two years ago for $95,000. At the time of purchase it had a 7-year life with an expected salvage value of $10,000. If sold today Dolphin expects to receive $55,000 for the machine. Dolphin depreciates all assets using straight-line depreciation. Dolphin currently has revenue of $700,000 that is expected to grow at 5% per annum. Dolphin currently has a gross profit margin of 17%.
New machinery today will cost $145,000. The new machinery is expected to last 5 years and has a salvage value of $15,000. The new machinery will lower annual operating costs by $5,000 per annum. In addition, the new machine is expected to increase expected revenue (shown below) and increase the firm’s gross profit margin to 19%.
Year 1 120,000
Year 2 130,000 Yr. 4 125,000
Year 3 140,000 Yr. 5 125,000
Assume a tax rate of 30% and a cost of capital of 11%. What is the NPV and IRR of the project?
Explanation / Answer
Data Current Machinary 1 Cost $ 95,000.00 2 Life 7 3 Salvage Value $ 10,000.00 4 Depreciation $ 12,142.86 (95000-10000)/7 5 Present Value Opening $ 95,000.00 Depreciation for 2 Years $ 24,285.71 Closing Value after 2 Years' $ 70,714.29 6 Current Market Price $ 55,000.00 7 Loss $ (15,714.29) (55000-70714.29) 8 Revenue $ 700,000.00 9 Growth 7% 10 Gross Margin 17% New Machinery 1 Cost $ 145,000.00 2 Life 5 3 Salvage $ 15,000.00 4 Depreciation $ 26,000.00 (145000-15000)/5 5 Cost Saving $ 5,000.00 6 Gross Margin 19% Calculation of NPV - OLD Machinery Year Expected Revenue Gross Margin 17% Tax @ 30% Deprectaion Net Cash Flow Discount Factor @ 11% Dicounted Cash Flow (A) (B=A X 17%) (C = B X 30%) (D) = Calculated (E= B-C+D) (F) (G = E X F) 1 $ 700,000.00 $ 119,000.00 $ 35,700.00 $ 12,142.86 $ 95,442.86 0.9009 $ 85,984.56 2 $ 749,000.00 $ 127,330.00 $ 38,199.00 $ 12,142.86 $ 101,273.86 0.8116 $ 82,196.13 3 $ 801,430.00 $ 136,243.10 $ 40,872.93 $ 12,142.86 $ 107,513.03 0.7312 $ 78,612.60 4 $ 857,530.10 $ 145,780.12 $ 43,734.04 $ 12,142.86 $ 114,188.94 0.6587 $ 75,219.79 5 $ 917,557.21 $ 155,984.73 $ 46,795.42 $ 12,142.86 $ 121,332.16 0.5935 $ 72,004.73 $ 394,017.81 Investment in Machinery $ 70,714.29 NPV $ 323,303.53 Calculation of NPV - New Machinery Year Expected Revenue Expected Increase In revenue Cost Savings Expected Revebue from New Machinery (A) (B) - Given (C) (D = A + B+ C) 1 $ 700,000.00 $ 120,000.00 $ 5,000.00 $ 825,000.00 2 $ 749,000.00 $ 130,000.00 $ 5,000.00 $ 884,000.00 3 $ 801,430.00 $ 140,000.00 $ 5,000.00 $ 946,430.00 4 $ 857,530.10 $ 125,000.00 $ 5,000.00 $ 987,530.10 5 $ 917,557.21 $ 125,000.00 $ 5,000.00 $ 1,047,557.21 Year Gross Margin 17% Tax @ 30% Deprectaion Net Cash Flow Discount Factor @ 11% Dicounted Cash Flow (E=D X 19%) (F = E X 30%) (G) = Calculated (H= E-F+G) (I) (J = H X I) 1 $ 156,750.00 $ 47,025.00 $ 26,000.00 $ 135,725.00 0.9009 $ 122,274.77 2 $ 167,960.00 $ 50,388.00 $ 26,000.00 $ 143,572.00 0.8116 $ 116,526.26 3 $ 179,821.70 $ 53,946.51 $ 26,000.00 $ 151,875.19 0.7312 $ 111,049.83 4 $ 187,630.72 $ 56,289.22 $ 26,000.00 $ 157,341.50 0.6587 $ 103,645.72 5 $ 199,035.87 $ 59,710.76 $ 26,000.00 $ 165,325.11 0.5935 $ 98,112.41 $ 551,608.99 Investment in Machinery $ 145,000.00 NPV $ 406,608.99 Calculation of IRR OLD Machinery Year Cash Flow i.e (E) Discount Factor @12% Discounted Cash Flow 1.4293 1 $ 95,442.86 0.8929 $ 85,216.84 0.699643182 $ 66,775.94 2 $ 101,273.86 0.7972 $ 80,734.90 0.489500582 $ 49,573.61 3 $ 107,513.03 0.7118 $ 76,525.65 0.342475745 $ 36,820.60 4 $ 114,188.94 0.6355 $ 72,569.14 0.23961082 $ 27,360.91 5 $ 121,332.16 0.5674 $ 68,847.13 0.167642076 $ 20,340.38 $ 383,893.65 $ 200,871.44 The IRR is by Interpolating Between 11% and 12% discounted Cash flow IRR =11% + $394017.81 - $70714.29 X 1% $394017.81 - $383893.65 IRR = 42.93 % NEW Machinery Year Cash Flow i.e (E) Discount Factor @12% Discounted Cash Flow 1 $ 135,725.00 0.8929 $ 121,183.04 2 $ 143,572.00 0.7972 $ 114,454.72 3 $ 151,875.19 0.7118 $ 108,101.76 4 $ 157,341.50 0.6355 $ 99,993.37 5 $ 165,325.11 0.5674 $ 93,809.91 $ 537,542.79 The IRR is by Interpolating Between 11% and 12% discounted Cash flow IRR =11% + $551608.99 - $145000 X 1% $551608.99 - $537542.79 IRR = 39.9068 % If we select the Proposal on the basis of NPV so New machinery has Higher NPV If we select the Proposal on the basis of IRR so Old machinery has Higher NPV
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