CASE STUDY #2 Due: July 31, 2018, 6:00 P.M On separate sheet(s) of paper answer

Question

CASE STUDY #2 Due: July 31, 2018, 6:00 P.M On separate sheet(s) of paper answer the questions accompanying the following case Summer, 2018 Show all work. Attach this sheet to your completed 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 $238,000. is being depreciated straight-äne over 7 years. It could be sold now for $69,500. The new GG machine will cost $253,000 with installation costs of $5,000. 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 551 1,000 80,000 $87,000 $77,000 343,000 3-6 7-8 $35,000 1. Caloulate the initial investment for this replacement project 2. Calculate the incremental annual cash flows for the project 3. The company's cost of capital is 8%. Assuming the GG machine is of average risk. calculate the replacement project's Net Present Value. Is the project acceptable? Why? acceptable? Why? company. Calculate the replacement project's Net Present Value based on a 4. Calculate the replacement project's Internal Rate of Return Is the project 5. Assume that this project's risk is assumed to be greater than average for the 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

Solution :

1) The initial investment of the replacement project will be all cost involved to bring the asset to working condition :

hence the cost will be = 253000 + 5000 installation cost = $258000

2) The incremental cash flow from the project will be the difference between the old and new project cash receipts hence it will be :

Year New Old Incremental cash flow 1 80000 51000 29000 2 80000 43000 37000 3-6 87000 40000 47000 7-8 77000 35000 42000

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