The great tech company is considering replacing one of its machines with a more
ID: 2804742 • Letter: T
Question
The great tech company is considering replacing one of its machines with a more efficient one. The old machine has a book value of $60,000 and a remaining useful life of 5 years. It can sell the old machine now for $ 265,000. The old machine is being depreciated by 120,000 per year straight line. The new machine has a purchase price of $ 1,175,000 an estimated useful life and 5 years MACRS class life and salvage value of $145,000. Annual economic savings is $255,000 if new machine is installed. Taxes 35% and WACC is 12.
a. Calculate the NPV and IRR of the project and make a decision.
b. If expected life of existing machine decreased what effect does this have on the cash flow, discuss only?
c. If R&D were $30,000, what effect on NPV? Discuss only.
PLEASE SHOW ALL WORK
Explanation / Answer
a) INCREMENTAL INITIAL INVESTMENT: Cost of the new machine 1175000 Less: Salvage value net of tax of the old machine: Sale value 265000 Book value 60000 Gain on sale 205000 Tax at 35% on gain 71750 Aftertax cash flow from sale of old machine 193250 Incremental initial investment 981750 ANNUAL OPERATING CASH FLOWS: 0 1 2 3 4 5 Annual savings 255000 255000 255000 255000 255000 Incremental depreciation: Depreciation on the new machine (MACRS 5 Yr) 235000 376000 225600 135360 135360 1107320 Depreciation on old machine 12000 12000 12000 12000 12000 Incremental depreciation 223000 364000 213600 123360 123360 Incremental net savings before tax 32000 -109000 41400 131640 131640 Tax at 35% 11200 -38150 14490 46074 46074 Incremental net savings after tax 20800 -70850 26910 85566 85566 Add: Incremental depreciation 223000 364000 213600 123360 123360 Add: Incremental after tax operating cash flows 243800 293150 240510 208926 208926 Capital expenditure 981750 -117938 Incremental project cash flows -981750 243800 293150 240510 208926 326864 PVIF at 12% 1 0.89286 0.79719 0.71178 0.63552 0.56743 PV at 12% -981750 217679 233697 171190 132776 185471 -40936 NPV -40936 Answer WORKING FOR TERMINAL NON OPERATING CASH FLOW: Salvage value of new machine 145000 Book value = 1175000-1107320 = 67680 Gain on sale 77320 Tax at 35% on gain 27062 After tax salvage value 117938 CALCULATION OF IRR: Incremental project cash flows -981750 243800 293150 240510 208926 326864 PVIF at 11% 1 0.90090 0.81162 0.73119 0.65873 0.59345 PV at 11% -981750 219640 237927 175859 137626 193978 -16721 PVIF at 10% 1 0.90909 0.82645 0.75131 0.68301 0.62092 PV at 10% -981750 221636 242273 180699 142699 202957 8514 IRR lies between 10% and 11% IRR = 10+8514/(8514+16721) = 10.34% (Answer) DECISION: As the NPV is negative (because of which IRRRelated Questions
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