PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, wh
ID: 2745329 • Letter: P
Question
PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $80 million on equipment with an assumed life of 5 years and an assumed salvage value of $25 million for tax purposes. The firm uses straight-line depreciation. The old equipment can be sold today for $70 million. A new modem pool can be installed today for $150 million. This will have a 3-year life and will be depreciated to zero using straight-line depreciation. The new equipment will enable the firm to increase sales by $25 million per year and decrease operating costs by $12 million per year. At the end of 3 years, the new equipment will be worthless. Assume the firm’s tax rate is 35% and the discount rate for projects of this sort is 15%.
What is the net cash flow at time 0 if the old equipment is replaced? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)
What are the incremental cash flows in years 1, 2, and 3? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)
What are the NPV and IRR of the replacement project? (Do not round intermediate calculations. Enter the NPV in millions rounded to 2 decimal places. Enter the IRR as a percent rounded to 2 decimal places.)
a.What is the net cash flow at time 0 if the old equipment is replaced? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)
Explanation / Answer
Answer A -84.2$
Answer B 41.55
Answer C NPV $10.67, IRR 23%
Year
Sale of old equipment ($ in M)
Sale of New equipment ($ in M)
Tax saving on depreciation (150/3)*35%
Increase in sales (Net of tax)
25-(25*35%)
Decrease in operating cost (Net of tax)
12-(12*35%)
Total cashflow
Dis factor @15%
Discounted cashflow
0
65.8
-150
-84.2
1
-84.2
1
17.5
16.25
7.8
41.55
0.869565
36.13043
2
17.5
16.25
7.8
41.55
0.756144
31.41777
3
17.5
16.25
7.8
41.55
0.657516
27.3198
IRR
23%
NPV
10.668
Net cash flow (70-4.2)
65.8
Tax 35%
4.2
Gain
12
Sale value
70
WDV of old equipment
58
Cost
80
2 years depreciation((80-25)/5)*2
22
Year
Sale of old equipment ($ in M)
Sale of New equipment ($ in M)
Tax saving on depreciation (150/3)*35%
Increase in sales (Net of tax)
25-(25*35%)
Decrease in operating cost (Net of tax)
12-(12*35%)
Total cashflow
Dis factor @15%
Discounted cashflow
0
65.8
-150
-84.2
1
-84.2
1
17.5
16.25
7.8
41.55
0.869565
36.13043
2
17.5
16.25
7.8
41.55
0.756144
31.41777
3
17.5
16.25
7.8
41.55
0.657516
27.3198
IRR
23%
NPV
10.668
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