WCX, Inc. is considering the replacement of its old stamping machine with a new
ID: 2757078 • Letter: W
Question
WCX, Inc. is considering the replacement of its old stamping machine with a new one. The old machine was purchased 3 years ago for $62,000 and was expected to last for 8 years. The old machine has been depreciated using straight-line depreciation with an expected salvage value at the end of its life of $6,000. The new machine will cost $84,000 and would be considered a MACRS 3 year asset. The new machine would have a useful life of 5 years and then be sold for $8,000. The new stamping machine would result in increased revenues of $12,000 per year and would cost an additional $2,000 per year to operate. If you decide to purchase the new machine, the old machine could be sold today for $40,000. The company has a 6% cost of capital and is in the 40% tax bracket. Its Cost Recovery Policy specifies 4 years as its payback requirement. Using payback period, discounted payback period, NPV, IRR, and MIRR, determine if this is a good project or not.
Explanation / Answer
Annual Depreciation of old machine = (62000-6000)/8 = 7000
Book value today of old machine = 62000 - 7000*3 = 41000
sale value of old machine = 40000
Loss on sale of old machine = 1000
Tax saving on loss = 1000*40% = 400
Initial Investment = new Machine cost - sale value of old machine
Initial Investment = 84000-40000
Initial Investment = 44000
Depreciation of New Machine in year 1 = 84000*33.33% = 27,997.20
Depreciation of New Machine in year 2 = 84000*44.45% = 37,338
Depreciation of New Machine in year 3 = 84000*14.81% = 12,440.40
Depreciation of New Machine in year 4 = 84000*7.41% = 6,224.40
After tax salvage value = 8000*(1-40%) = 4800
Cash Flow :
Year 1 = ( increased revenues-Increase cost)*(1-tax rate) + Increased/Decreased Depreciation * tax rate + Tax saving on loss of old machine
Year 1 = (12000-2000)*(1-40%) + (27997.20-7000)*40% + 400
Year 1 = 14,798.88
Year 2 = ( increased revenues-Increase cost)*(1-tax rate) + Increased/Decreased Depreciation * tax rate
Year 2 = (12000-2000)*(1-40%) + (37338-7000)*40%
Year 2= 18,135.20
Year 3 = ( increased revenues-Increase cost)*(1-tax rate) + Increased/Decreased Depreciation * tax rate
Year 3 = (12000-2000)*(1-40%) + (12440.40-7000)*40%
Year 3= 8,176.16
Year 4 = ( increased revenues-Increase cost)*(1-tax rate) + Increased/Decreased Depreciation * tax rate
Year 4 = (12000-2000)*(1-40%) + (6224.4-7000)*40%
Year 4= 5,689.76
Year 5 = ( increased revenues-Increase cost)*(1-tax rate) + Increased/Decreased Depreciation * tax rate + after tax salvage value
Year 5 = (12000-2000)*(1-40%) + (0-7000)*40% + 4800
Year 5 = 8000
1) Payback period = 3 + 2889.76/5689.76
Payback period = 3.51 Years
2) Discounted payback period
Discounted payback period = 4 + 2526.84/5978.07
Discounted payback period= 4.42 Years
3)
NPV = -44000 + 14,798.88/1.06 + 18,135.20/1.06^2 + 8,176.16/1.06^3 + 5,689.76/1.06^4 + 8,000.00/1.06^5
NPV = $ 3451.22
4)
At IRR
PV of Cash Inflow = PV of cash outflow
14,798.88/(1+r) + 18,135.20/(1+r)^2 + 8,176.16/(1+r)^3 + 5,689.76/(1+r)^4 + 8,000.00/(1+r)^5 = 44000
By using trial run error method solving r
we get
IRR = 9.40%
5)
MIRR = (FV of Cash Inflow/PV of Cash outflow)^(1/n) - 1
FV of Cash Inflow = 14,798.88*1.06^4 + 18,135.20*1.06^3 + 8,176.16*1.06^2 + 5,689.76*1.06 + 8,000.00
FV of Cash Inflow = 63500.44
PV of Cash outflow = 44000
MIRR = (63500.44/44000)^(1/5) -1
MIRR = 7.61%
Decision: It is a good project since it payback period is less than Cost Recovery Policy specifies 4 years and NPV is positive, MIRR & IRR is greater than cost of capital
Year Cash Flow Cummulative Cash Flow 0 (44,000.00) (44,000.00) 1 14,798.88 (29,201.12) 2 18,135.20 (11,065.92) 3 8,176.16 (2,889.76) 4 5,689.76 2,800.00 5 8,000.00 10,800.00Related Questions
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