Question

The Computer company is evaluating the replacement of one of its machines. The machine was originally purchased ten years ago at a cost of $35,000 and has been depreciated to a book value of zero. If Pioneer replaces the machine, it will be able to bid on larger projects that require the capabilities of the new machine. The new machine will cost the firm $80,000, which will be depreciated over 4 years according to the following depreciation rates: 40% in each of years 1 and 2, and 10% in each of years 3 and 4. The new machine qualifies for an immediate 2% investment tax credit. Pioneer anticipates that at the end of the machine’s eight year economic life it will be sold for $10,000. Pioneer estimates that its existing machine can be sold today for $5,000. If Pioneer does not replace the machine, it anticipates being able to use the existing machine for eight more years at which time its salvage value would be zero. Without the purchase of the new machine, Pioneer expects to generate revenue of $200,000 per year. The firm’s use of its existing machine is expected to generate operating expenses of $120,000 per year. If the new machine is purchased, Pioneer expects the firm’s annual revenues and operating costs to increase to $270,000 and $170,000 respectively. Pioneer’s marginal tax rate is 40%. To finance this project, Pioneer will raise 30% of the capital from debt and 70% of the capital from equity; its after-tax cost of debt is 8% and the cost of equity is 18%. a. Calculate the NPV for this project. b. Calculate the IRR for this project; you should use Excel to do this. Calculate the IRR to 2 decimals; for example, 25.63%.

Answer 1