A firm is considering an investment in a new machine with a price of $18.05 mill
ID: 2773308 • Letter: A
Question
A firm is considering an investment in a new machine with a price of $18.05 million to replace its existing machine. The current machine has a book value of $6.05 million and a market value of $4.55 million. The new machine is expected to have a four-year life, and the old machine has four years left in which it can be used. If the firm replaces the old machine with the new machine, it expects to save $6.75 million in operating costs each year over the next four years. Both machines will have no salvage value in four years. If the firm purchases the new machine, it will also need an investment of $255,000 in net working capital. The required return on the investment is 11 percent, and the tax rate is 34 percent. Assume the company uses straight-line depreciation.
What is the NPV of the decision to purchase a new machine? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16). Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)
What is the IRR of the decision to purchase a new machine? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16))
What is the NPV of the decision to purchase the old machine? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16). Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Negative amount should be indicated by a minus sign.)
What is the IRR of the decision to purchase the old machine? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16). Negative amount should be indicated by a minus sign.)
What is the NPV of the decision to purchase a new machine? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16). Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)
What is the IRR of the decision to purchase a new machine? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16))
What is the NPV of the decision to purchase the old machine? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16). Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Negative amount should be indicated by a minus sign.)
What is the IRR of the decision to purchase the old machine? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16). Negative amount should be indicated by a minus sign.)
Explanation / Answer
1. NPV :- present value of cash inflow-present value of cash outflow
Present value of cash outlow:-
cost of new machine:-$18.05 million
less sale of old machine:- $4.55 million
less tax benefit of capital loss on sale of old plant:-0.51 million
add additional working capital 0.255
Net cash outflow:- $13245000
Present value of cash inflow:-
NPV:- present value of cash inflow - present value of cah outflow
=$17156000-13245000
= $3911000
b) IRR is that rate at which NPV is zero here in the question NPV@11% is positive is means IRR of the project is higher than that so the IRR is 11.82% (by using financial calculator)
1 year ($) 2 nd year ($) 3rd year ($) 4th year ($) saving in cost(A) 6.75 6.75 6.75 6.75 -incremental depreciation(depreciation of new machine-depreciation on old machine)(B) 3 3 3 3 Increase in profit(A-B) 3.75 3.75 3.75 3.75 -Tax@34% 1.275 1.275 1.275 1.275 profit after tax 2.475 2.475 2.475 2.475 depreciation added back 3 3 3 3 add release of working capital 0 0 0 0.255 total cash inflow 5.475 5.475 5.475 5.73 PVF@11% 0.901 0.812 0.731 0.659 Present value of cash inflow 4.93 4.45 4 3.776 Total present value of cash inflow = $17156000Related Questions
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