Question

ACME manufacturing is considering replacing an existing production line with a new

line that has a greater output capacity and operates with less labour than the existing

line. The new line would cost $1 million, have a 5-year life, and would be depreciated

using the straight-line depreciation method over 5 years. At the end of 5 years, the new

line could be sold as scrap for $200 000 (in year 5 dollars). Because the new line is more

automated, it would require fewer operators, resulting in a saving of $40 000 per year

before tax and unadjusted for inflation (in today’s dollars). Additional sales with the new

machine are expected to result in additional net cash inflows, before tax, of $60 000 per

year (in today’s dollars). If ACME invests in the new line, a one-time investment of $10

000 in additional working capital will be required. The tax rate is 30 per cent, the

opportunity cost of capital is 10 per cent, and the annual rate of inflation is 3 per cent.

What is the NPV of the new production line?

Note: show workings how to calculate the revenue, op exp, and PV of net cash flows.

Answer 1

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