PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, wh
ID: 2765461 • Letter: P
Question
PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $75 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 $120 million. A new modem pool can be installed today for $240 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 $39 million per year and decrease operating costs by $19 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 13%.
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.) Incremental cash flow $ million per year
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.) NPV $ million IRR %
Explanation / Answer
What is the net cash flow at time 0 if the old equipment is replaced?
Annual depreciation =(75-25)5 =10 Book value at the time of sale is $75- (10*2) = $55 million. capital Gain =120-55 =65 Tax =65*.35 = 22.75 After tax sales proceeds =120-22.75 =97.25 the net cash outlay at time 0 is 240-97.25 =142.75Related Questions
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