PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, wh
ID: 2790752 • Letter: P
Question
PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $105 million on equipment with an assumed life of 5 years and an assumed salvage value of $10 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 million per year and decrease operating costs by $18 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%. depreciated to zero using straight-line depreciation. The new equipment will enable the firm to increase sales by $37 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 celculations. Enter your answer in millions rounded to 2 decimal places.) Net cash tow (148 30) mition b. What are the incremental cash flows in years 1,2. and 3? (Do not round intermediate calculetions. Enter your answer in millions roundéd to 2 decimel places.) incremental cash flow miltion per year c. What are the NPV and IRR of the replacement project? (Do not round intermediate celculations. Enter the NPV in millions rounded to 2 decimal places. Enter the IRR as a percent rounded to 2 decimel places.)Explanation / Answer
a)
New asset cost = 240
Old asset book value = 105 - (2*(105-10)/5) = 67
After tax profit on old asset = (1-35%)*(120 - 67) = 34.45
Intial investment = -240+67+34.45 = -138.55
2)
Increase in OCF = after tax increase in cashflow + depreciation tax shield
= (1-35%)*(37+18) + (240/3)*35% = 63.75
3)
NPV = -138.55 + 63.75*PV(9%,3,-1)
= -138.55 + 63.75*2.53
= 22.82 million
IRR = RATE(3,63.75,-138.55)
= 18.03%
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