Question

Orgler Label Company is thinking about replacing an existing press. The     existing press was purchased 6 years ago for $155,000 with a salvage value of $8,000. It will last for four more years and it is expected to be worthless at that time.   It can be sold today for $50,000.

                  A new high-speed press can be purchased for $195,000 with an expected salvage value of $30,000 at the end of its four-year life.

            Orgler current revenue is $2,000,000 and is expected grow 6% per annum. The new machine would have increased current revenue to $2,200,000. Firm revenue will continue to grow by 6% per annum if they acquire the new machine. Orgler average collection period is 55 days and pays it bills after 25 days.   Orgler has a gross profit margin of 28%. The new press will increase labor costs by $9,000 per year.   Orgler uses 9% for its cost of capital and has an ordinary income tax rate of 30%. The project will be 50% financed with a 7% 3-year loan. The firm uses straight line depreciation.   Calculate the project’s NPV.   

Answer 1

First of all let us calculate Book value of existing machine

Depreciation on old machine = cost less salvage value/ Expected useful life

=155000-8000/10

=14700$

Depreciation for 6 years = 14700*6 = 88200$

Book value of old machine = 155000-88200 = 66800$

Thus cash flow from old machine if it is sold today

Paticulars	Amount
Selling price	50000
BV	66800
Loss	16800
Tax savings @ 30%	5040
Total cash flow(50000+5040)	55040

Now we will calculate Installment if new machine is purchased

Installment = Loan/PVIFA(7%,3)

=(195000*50%) / 2.624

=97500/2.624

=37152.5$

Statement showing bifercation of intrest and principle

			Towards
Year	Opening balance	Installment	Int @ 7%	Principal	Closing balance
1	97500	37153	6825	30328	67173
2	67173	37153	4702	32450	34722
3	34722	37153	2431	34722	0

Now let us calculate depreciation

=195000-30000/4 = 41250$

Incremental depreciation = 41250-14700 = 26550$

Statement showing NPV

Particulars	0	1	2	3	4	Total
Purchase price of new machine	-97500
Proceeds from sale of old machine	55040
Incremental revenue		200000	212000	224720	238203
Gross Profit margin		56000	59360	62922	66697
Increase in labour cost		-9000	-9000	-9000	-9000
Interest expense		-6825	-4702	-2431
Depreciation		-26550	-26550	-26550	-26550
PBT		13625	19108	24941	31147
Tax @30%		4088	5732	7482	9344
PAT		9538	13376	17459	21803
Add: depreciation		26550	26550	26550	26550
Annual cash flow		36088	39926	44009	48353
Incremental salage value					22000
Payment of loan( principal portion)		-30328	-32450	-34722
Total cash flow	-42460	5760	7475	9287	70353
PVIF @ 9%	1	0.9174	0.8417	0.7722	0.7084
Present value	-42460	5284	6292	7171	49840	26127

Thus NPV = 26127$