PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, wh
ID: 2764849 • Letter: P
Question
PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $140 million on equipment with an assumed life of 5 years and an assumed salvage value of $20 million for tax purposes. The firm uses straight-line depreciation. The old equipment can be sold today for $100 million. A new modem pool can be installed today for $210 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 $28 million per year and decrease operating costs by $14 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 9%.
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.)
b)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.)
c)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.)
Explanation / Answer
Answer a 97.2
Old equipment cost
140
Depreciatio of 2 years (((140-20)/5)*2)
48
Book value at year 0
92
Sales price
100
Gain
8
Tax 35%
2.8
Net gain
5.2
cashflow
97.2
Answer b
Year
sale of old equipment
New equipment
tax saving on Depreciation
Increase in sales post tax
Decrease in operatin cost
Incremental cashflow
0
97.2
-210
-112.8
1
73.5
18.2
9.1
100.8
2
73.5
18.2
9.1
100.8
3
73.5
18.2
9.1
100.8
Answer c
Year
sale of old equipment
New equipment
tax saving on Depreciation
Increase in sales post tax
Decrease in operatin cost
Incremental cashflow
Dis @9%
Discounted cashflow
0
97.2
-210
-112.8
1
-112.80
1
73.5
18.2
9.1
100.8
0.92
92.48
2
73.5
18.2
9.1
100.8
0.84
84.84
3
73.5
18.2
9.1
100.8
0.77
77.84
NPV
142.35
Year
sale of old equipment
New equipment
tax saving on Depreciation
Increase in sales post tax
Decrease in operatin cost
Incremental cashflow
0
97.2
-210
-112.8
1
73.5
18.2
9.1
100.8
2
73.5
18.2
9.1
100.8
3
73.5
18.2
9.1
100.8
IRR
IRR(L7:L10)
72%
Old equipment cost
140
Depreciatio of 2 years (((140-20)/5)*2)
48
Book value at year 0
92
Sales price
100
Gain
8
Tax 35%
2.8
Net gain
5.2
cashflow
97.2
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