please help me out with 5 and 6, and show all the work AADR Corporation is consi
ID: 2654114 • Letter: P
Question
please help me out with 5 and 6, and show all the work AADR Corporation is considering the replacement of its Grounding Grinding (GG) machine. The old machine was purchased 4 years ago at an installed cost of $322,000. It is being depreciated straight-line over 7 years. It could be sold now for $149,500. The new GG machine will cost $410,000 with installation costs of $16,000. It will be depreciated straight-line over 6 years. The firm?s tax rate is 40%. Estimated annual Net Cash Benefits for the two GG machines are: 1. Calculate the initial investment (t = 0) for this replacement project. 2. Calculate the incremental cash flows for each year. 3. The company^?s cost of capital is 9%. Assuming the GG machine is of average risk, calculate the replacement project^?s Net Present Value. Is the project acceptable? Why? 4. Calculate the replacement project^?s Internal Rate of Return. Is the project acceptable? Why? 5. Assume that this project^'s risk is assumed to be greater than average for the company. Calculate the replacement project^?s Net Present Value based on a risk adjusted interest rate of 11%. 6. Using Internal Rate of Return, is the replacement project acceptable based on the assumption of higher risk? Why?Explanation / Answer
(‘5) Replacement Project’s NPV based on Risk Adjusted Rate of Interest
Calculation of Discounted Cash Inflow
Year
Net Cash Benefit (a)
Depreciation
( $ 426,000/ 6 years ) (b)
Cash Benefit post depreciation
C= (a-b)
Post Tax Benefit
D= c x 60 %
Cash Inflow
E=( d + b)
DF @ 11 %
Discounted Cash Flow
1
70,000
71,000
-1,000
-600
70,400
0.901
63,423
2
70,000
71,000
-1,000
-600
70,400
0.812
57,138
3
77,000
71,000
6,000
3,600
74,600
0.731
54,547
4
77,000
71,000
6,000
3,600
74,600
0.659
49,141
5
77,000
71,000
6,000
3,600
74,600
0.593
44,271
6
77,000
71,000
6,000
3,600
74,600
0.535
39,884
7
67,000
67,000
40,200
40,200
0.482
19,363
8
67,000
67,000
40,200
40,200
0.434
17,444
93,600
345,211
Calculation of Post Tax Salvage Value
Original Cost
322,000
Lest Depreciation ( 46000 x 4)
184,000
Net Value
138,000
Salvage Value
149,500
Less : Tax ( 149500-138000 ) x 40 %
4,600
Post Tax Salvage Value
144,900
Net Present Value
= Present Value of Cash Inflow + Present Value of Salvage Value – Initial Investment
NPV= 345,211+144,900-426,000
NPV= $ 64,111
(‘6) Internal Rate of Return for Replacement Project
NPV of Project at 17 % = 285,937
NPV ( 18 % )= 277,660
While Net Initial Investment = 281,100 ( 426000- 144900)
While calculating IRR by interpolation
We get IRR
= Start Rate + ( NPV at lower rate – Initial Investment )/ ( NPV at lower rate – NPV at higher rate) x Difference in Rate
= 17 % + 4837/ 8270
IRR = 17.58 %
As IRR is more than risk adjusted rate of return, hence replacement project should be accepted.
Year
Net Cash Benefit (a)
Depreciation
( $ 426,000/ 6 years ) (b)
Cash Benefit post depreciation
C= (a-b)
Post Tax Benefit
D= c x 60 %
Cash Inflow
E=( d + b)
DF @ 11 %
Discounted Cash Flow
1
70,000
71,000
-1,000
-600
70,400
0.901
63,423
2
70,000
71,000
-1,000
-600
70,400
0.812
57,138
3
77,000
71,000
6,000
3,600
74,600
0.731
54,547
4
77,000
71,000
6,000
3,600
74,600
0.659
49,141
5
77,000
71,000
6,000
3,600
74,600
0.593
44,271
6
77,000
71,000
6,000
3,600
74,600
0.535
39,884
7
67,000
67,000
40,200
40,200
0.482
19,363
8
67,000
67,000
40,200
40,200
0.434
17,444
93,600
345,211
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