Question

6. You are considering replacing the plastic extrusion machine that create basic moldings of the outdoor pool furniture your company produces. The current extrusion machine was purchased two years ago for $240,000 and is being depreciated on the straight line basis over 5 years towards a zero salage value. Although the old machine is anticipated to have a salvage value of $40,000 three years from now, it can be sold today for $150,000. The new machine costs $400,000 and will be depreciated on a straightline basis toward a zero-salvage value over a 5-year period. At the end of three years, you expected to be able to sell it for and $50,000. You have estimated that the more modern form of the furniture will result in sales increasing of $220,000 per year. Manufacturing costs are anticipated to increase $120,000 per year. The firm is in the 40% tax bracket.

a. What are the net of free cash flow for each year?

b. Assume the answer of part a is as follow:

Year 0 Year 1 Year 2 Year 3
Net Cash Flow $(275,000) $115,000 $140,000 110,000

What is the IRR for this project?

Answer 1

Answer a:

Current extrusion machine:

The current extrusion machine was purchased two years ago for $240,000 and is being depreciated on the straight line basis over 5 years towards a zero salvage value.

Depreciation per year = (Cost of machine - Salvage value) /Useful life = (240000 - 0) /5 = $48,000

Hence:

Book value of machine = 240000 - (48000 * 2) = $144,000

Sale value now = $150,000

Tax on gain = (150000 - 144000) * 40% = $2,400

Sale value net of tax = 150000 -2400 = $147,600

The net of free cash flow for each year are calculated and given below:

Answer b:

IRR = 15.70%

Working: