Question

Based on the information provided below, Should the company proceed with the investment? Use NPV & IRR to evaluate the project.                                                                                                    

                                                                                    Old Machine            Proposed new Machine

Asset cost                                                                     $150,000            $180,000

Age of machine                                                             10 years            0 years

Useful Life                                                                   15 years            5 years

Salvage value                                                                $15,000            0

Revenue                                                                       $500,000            $550,000

Maintenance cost                                                          $6,000                   $10,000

Electricity cost                                                              $20,000             $25,000

Shipping cost                                                                -                       $6,000

Freight insurance                                                          -                       $2,000

Installation & Commissioning expense                           -                       $12,000

Working capital:

Cash                                                                             $15,000             $25,000

Trade debtors                                                                $30,000             $40,000

Inventory                                                                      $24,000             $34,000

Trade creditors                                                              $40,000             $50,000

Accruals                                                                       $10,000             $15,000

Current portion of long-term Loan                                  $8,919             $15,977

Long-term Loan (non-current portion)                            $46,435             $84,022

Interest rate                                                                     10.75%            11.25%

Interest Expense                                                            $7,539             $11,250

Instalment payment                                                       $16,458             $27,227

Depreciation is on straight-line method. The current machine can be sold today for $75,000. The new machine can reduce labour by cutting cost from $36,000 to $30,000 a year. The estimated selling price of the new machine at the end of its useful life is $35,000. Should company proceed with the replacement, they have to use their other factory lot now leased to a third party for $700 per month. The company spent $30,000 on rewiring/renovation of the factory now leased to the third party. It is expected that only 90% of company’s investment in working capital will be recovered. Company’s tax rate is 40% and its WACC is 11.00%

Answer 1

For solving this problem firstly net wrorking capital is calculated after which EBIDTA is calculated and then the rest of the calculations as given in the below snapshots are done. The final answer is not to replace the machine as NPV of free cash flows and the IRR as well are negative so no benefit will be obtained from replacing the machine.

The first image explains the working of net working capital along with the amount spent at 0th interval i.e. at the time of installation of new machine

This image explains the rest of the workings which shows that overall the NPV and the IRR for the project is negative hence the asset should not be replaced. One thing not taken into account is the opportunity cost, there can be some opportunity cost as well involved but just for the sake of simplicity it is not taken into account.