You have been asked if the baseball lathe needs to be replaced. The one in curre
ID: 2722859 • Letter: Y
Question
You have been asked if the baseball lathe needs to be replaced. The one in current use was bought 4 years ago at a cost of $540,000. At the time of purchase it had a nine-year life and your firm has been depreciation it using straight-line depreciation to a salvage value of zero. It can be sold today for $150,000. You have hired a consultant to determine the best replacement for the machine. The consultant has charged you $40,000 for his services.The one (with 5-year Economic life) he suggests has a cost of $850,000 and will need $50,000 worth of modifications to adapt it to your firm’s purposes. The firm has decided it can use a 5-year MACRS depreciation schedule for this machine. You expect that they can sell the machine at the end of the project (end of year 5) for $100,000. This firm expects that they can save $240,000 before tax each year if they replace the old machine. The firm has a WACC of 13.00% and ahs a marginal tax rate of 35%. The machine will allow the firm to reduce working capital by $20,000. What is the NPV of the project? What are the MIRR, IRR and the PI of the project? Should you recommend the project to your firm? Why?
Explanation / Answer
The following assumptions will be used for calculating the NPV of the project
The assets value is $850,000
The modification cost is $50,000
The consultant fee is $40,000
So the initial investment in year 0 is $ 9,40,000 adding all above
The savings per year before tax is $240,000
The savings on reduction on net working capital $20,000
The cost of capital is 13%
The depreciation is on 5 years MACRS depreciation schedule
The tax rate is 35%
The salvage value of old machine now is $ 150,000
The depreciation of old equipment for next 5 Year at SLM method is $5,40,000 /7 is $77143per year
The salvage value of new equipment is $ 100,000
The calculation of NPV is given below
the NPV is negative means cash inflows are less than outflows by $17,716 so do not recommend the project
the IRR is 9.05%
The profitabilty index of project = 772284/790000 = 0.98 or > 1
any project is accepted if PI is greater than 1
NPV calculation year equipment cost Cash inflows Depreciation of new asset MACRS 5 year schudule depreciation of old asset Net depreciatiom savings before tax tax @.35 savings after tax add -: deprecition annual cash inflow pV factor @13% cash inflow at present value 900000 1 260,000.00 180000 77143 102857 157,143.00 55,000 102,143 102857 205,000 0.884956 181,416 2 260,000.00 288000 77143 210857 49,143.00 17,200 31,943 210857 242,800 0.783147 190,148 3 260,000.00 172800 77143 95657 164,343.00 57,520 106,823 95657 202,480 0.69305 140,329 4 260,000.00 103680 77143 26537 233,463.00 81,712 151,751 26537 178,288 0.613319 109,347 5 260,000.00 103680 77143 26537 233,463.00 81,712 151,751 26537 178,288 0.54276 96,768 718,008 Present value of cash inflows for 5 years 718,008 present value of scrap value at end of 5 years (100000 @ 0.54276 54276 present value of total cash inflow 772,284 less present value of cash outflow 790000 (940,000 - 150,000) Net NPV (17,716)Related Questions
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