A firm has decided to renew part of its production process by acquiring a new an

Question

A firm has decided to renew part of its production process by acquiring a new and more efficient machine at a cost of $24 million which can be depreciated on a linear basis over 4 years. Given its increased productivity, the new machine is expected to increase EBITDA (=Sales – Costs) by $10 million over its existing level at the end of the first year and this level should stay constant for the rest of the project. Working capital requirements are 5% of sales, and also expected to stay constant over the life of the project. At the end of the project, the resale market value of the machine is expected to be $5 million. The tax rate on earnings and capital gains is 30%, and the cost of capital is 12%. Calculate the NPV of the project.

Explanation / Answer

Answer :

Initial Outlay = FCInv + NWCInv

                    = 24 + (5% of 10 ) = 24.5 million

After Tax operating cash flows, CF = (S-C) * (1-T) + (T * D)

T = Marginal Tax rate = 30 %

D = Depreciation = 24 / 4 = 6 million

S-C = 10 million

1-T = 0.7

CF ( In any of the year ) = 10 * 0.7 + 0.3 * 6 = 8.8

TNOCF = Terminal Non Operating Cash flow = Sal + NWCInv - T * (Sal - B)

             = 5 + 0.5 - 0.3 * (5-0)

            = 5.5 -1.5 = 4 million

NPV = -24.5 + [ 8.8 / 1.12 + 8.8 / 1.122 + 8.8 / 1.123 + (8.8 +4) / 1.124 ]

         = $4.77 million

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