Dave Co. owns aging machines and is considering buying a new ones. Dave Co. is c
ID: 2773831 • Letter: D
Question
Dave Co. owns aging machines and is considering buying a new ones. Dave Co. is considering replacing their older machines to take advantage of the higher potential dayrates for their contracts over the next five years. Dave Co. current produces annual revenues of $35 M per machine with cash costs of $16 M per machine. The older machines also currently have $5 M tied up in NWC per machine. The controller of the company has estimated annual revenues for newbuild machines at $269 M per machine with cash costs of $30 M per machine. The new machines would require $15 M in NWC each. The purchase price of a new machine is $750 M. They expect to depreciate this on a straight-line basis to zero over the next five years. However, the company estimates that a new machine could be sold for $400 M at the end of the project. If they purchased a new machine today, they could sell an old one on the open market for $30 M. The old machines are currently carried on the books at $35 M each and are being depreciated on a straight-line basis by $5 M per year. If they decided to stick with the old machines, they expect them to have a market value of only $15 M in five years. Assume that Dave Co. faces a 40% corporate tax rate and an 17% cost of capital. What is the NPV of the decision (in $M per machines) to replace the old machines with the new ones?
Explanation / Answer
Dave CO NPV Calculation Details per machine in $ Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Discounting factor @17% 1 0.8547 0.4998 0.2923 0.1709 0.1000 Old Machine Revenue 35,000,000 35,000,000 35,000,000 35,000,000 35,000,000 Cash Cost (16,000,000) (16,000,000) (16,000,000) (16,000,000) (16,000,000) NWC (5,000,000) (5,000,000) (5,000,000) (5,000,000) (5,000,000) Depreciation (5,000,000) (5,000,000) (5,000,000) (5,000,000) (5,000,000) Income Before Tax 9,000,000 9,000,000 9,000,000 9,000,000 9,000,000 Income Tax @40% 3,600,000 3,600,000 3,600,000 3,600,000 3,600,000 Net Income 5,400,000 5,400,000 5,400,000 5,400,000 5,400,000 Add back depreciation 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000 Add Salvage value 15,000,000 Total Cash Flow 10,400,000 10,400,000 10,400,000 10,400,000 25,400,000 PV of Cash Flows 8,888,889 5,198,181 3,039,872 1,777,703 2,539,004 NPV 21,443,648 New Machine Investment (750,000,000) Revenue 269,000,000 269,000,000 269,000,000 269,000,000 269,000,000 Cash Cost (30,000,000) (30,000,000) (30,000,000) (30,000,000) (30,000,000) NWC (15,000,000) (15,000,000) (15,000,000) (15,000,000) (15,000,000) Depreciation (150,000,000) (150,000,000) (150,000,000) (150,000,000) (150,000,000) Income Before Tax 74,000,000 74,000,000 74,000,000 74,000,000 74,000,000 Income Tax @40% 29,600,000 29,600,000 29,600,000 29,600,000 29,600,000 Net Income 44,400,000 44,400,000 44,400,000 44,400,000 44,400,000 Add back depreciation 150,000,000 150,000,000 150,000,000 150,000,000 150,000,000 Add Salvage value 30,000,000 400,000,000 Total Cash Flow 194,400,000 194,400,000 194,400,000 194,400,000 594,400,000 PV of Cash Flows 412,788,118 166,153,846 97,165,992 56,822,217 33,229,367 59,416,696 NPV (307,211,882) So, NPV of decision to replace old machine with new one is $-(307.20)M
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