PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, wh

Question

PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $120 million on equipment with an assumed life of 5 years and an assumed salvage value of $13 million for tax purposes. The firm uses straight-line depreciation. The old equipment can be sold today for $80 million. A new modem pool can be installed today for $150 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 $25 million per year and decrease operating costs by $10 million per year. At the end of 0 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 10%.

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.)

-70,980.00 mil (marked incorrect)

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.)

22,750.00 mil (marked incorrect)

  

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.)

$29,115,792.64 NPV 32.12% IRR (marked incorrect)

Ive included the answers entered and all were incorrect :/

Explanation / Answer

IRR= 32.35%

NPV of replacement project is $29.11 million and IRR is 32.35%

Solution: Calculation of Book Value of old equipment- Cost of old equipment - $120 million Salvage Value of Old Equipment- 13 million Life of Old Equipment - 5 years Depreciation of old equipment = (120-13)/ 5 = 21.40 million Book Value of old equipment= 120- 21.40*2= 77.20 million Sale value of old equipment = $80 million Capital gain on Sale of old equipment = (80-77.20)*35%= 0.98 million Net Sale Proceeds from sale of old equipment = $80-0.98= $79.02 million a) Net Cash Flow at time 0 if old equipment replaced Cost of New Modern Pool= $ 150 million Net Cash Flow at time 0 = $150-$79.02 = $70.98 million Net Cash Flow at time 0= -$70.98 million b) Incremental Cash Flows in years 1 , 2 & 3 Increase in sales= $25 million Decrease opportunity costs= $10 million Depreciation on new equipment = $150/3= $50 million Incremental Cash Flows = (Increase in sales + Decrease in cost )(Net of Tax) + Tax Saving on Depreciation Incremental Cash Flows at year 1,2 &3= (25+10)*(1-0.35)+ 50*0.35= $40.25 million c) NPV = Present Value of CashInflows - Present Value at Cash Outflows NPV( at 10%)= $40.25million *(PVAF @10%, 1-3 years) - $70.98 million *1 NPV = $40.25 million*2.4868 -$70.98 million= $ 29.11 million NPV( at 33%)= $40.25million *(PVAF @33%, 1-3 years) - $70.98 million *1 NPV= $40.25 million * 1.7423 - $70.98million *1= - $0.85 million IRR= Lower Rate + (Lower Rate NPV/ Lower Rate NPV- Higher Rate NPV)*Difference in rates IRR= 10% + (29.11/29.11-(-0.85))*23% IRR= 10%+ (29.11/29.96)*23%

IRR= 32.35%

NPV of replacement project is $29.11 million and IRR is 32.35%

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