Question

A small factory is considering replacing its existing coining press with a newer, more efficient one. The existing press was purchased five years ago at a cost of $145,000, and it is being depreciated according to a 7-year MACRs depreciation schedule. The CFO estimates that the existing press has 6 years of useful life remaining. The purchase price for the new press is $274,000. The installation of the new press would cost an additional $36,000, and this cost would be added to the depreciable base. The new press (if purchased) would be depreciated using the 7-year MACRs depreciation schedule. Interest expenses associated with the purchase of the new press are estimated to be roughly $8,200 per year for the next 6 years. The appeal of the new press is that it is estimated to produce a pre-tax operating cost savings of $78,000 per year for the next 6 years. Also, if the new press is purchased, the old press can be sold for $25,000 today. The CFO believes that the new press would be sold for $29,000 at the end of its 6-year useful life. Assume that NWC would not be affected. The company has an average tax rate of 28% and a marginal tax rate of 31%. The cost of capital (i.e., discount rate) for this project is 13.20%. Develop the incremental cash flows for this replacement decision and use them to calculate NPV, IRR, and MIRR. Then offer a recommendation on whether or not the existing coining press should be replaced at this time. And please make sure that it is easy to follow how you arrived at your incremental cash flows! (20 points)

Answer 1

		DEPRECIATION OF EXISTING PRESS
		Cost of existing press	$145,000
		Year(frompurchase date)	1	2	3	4	5	6	7	8
	A	7 year MACRS depreciation Rate	14.29%	24.49%	17.49%	12.49%	8.93%	8.92%	8.93%	4.46%
	B1=A*145000	Depreciation	$20,721	$35,511	$25,361	$18,111	$12,949	$12,934	$12,949	$6,467
		Accumulated Depreciation	$20,721	$56,231	$81,592	$99,702	$112,651	$125,585	$138,533	$145,000
		Year(frompurchase date)	6	7	8
	N	Year FromToday	1	2	3	4	5	6
	B1	Depreciation 0f old Existing Press	$12,934	$12,949	$6,467	$0	$0	$0
		Book Value of existing system now	$32,350	(145000-112651)
		Before tax salvage value	$25,000
		Loss on sale	$7,350
		Tax Saving on loss =7350*31%	$2,278
		After tax Cash Flow on Salvage	$27,278	(25000+2278)
		DEPRECIATION OF NEW PRESS
		Depreciable base of New Press	$310,000	(274000+36000)
	N	Year(from today)	1	2	3	4	5	6
	A	7 year MACRS depreciation Rate	14.29%	24.49%	17.49%	12.49%	8.93%	8.92%
	B2=A*310000	Depreciation	$44,299	$75,919	$54,219	$38,719	$27,683	$27,652
		Accumulated Depreciation	$44,299	$120,218	$174,437	$213,156	$240,839	$268,491
		Book Value at end of 6 years	$41,509	(310000-268491)
		Before tax salvage value	$29,000
		Loss on sale	$12,509
		Tax Saving on loss =12509*31%	$3,878
		Salvage Cash flow at end of year 6	$32,878	(29000+3878)
		Present value of Cash Flow=(Cash Flow)/((1+i)^N)
		i=discount Rate =13.2%=0.132
		N=Year of Cash Flow
	N	Year From Today	1	2	3	4	5	6
	C=B2-B1	Incremental Depreciation	$31,365	$62,971	$47,752	$38,719	$27,683	$27,652
	D=C*31%	Depreciation tax shield	$9,723	$19,521	$14,803	$12,003	$8,582	$8,572
	E	Before tax saving in operating cost	$78,000	$78,000	$78,000	$78,000	$78,000	$78,000
	F	Interest expenses for new press	($8,200)	($8,200)	($8,200)	($8,200)	($8,200)	($8,200)
	G=E+F	Before tax net savings	$69,800	$69,800	$69,800	$69,800	$69,800	$69,800
	H=G*(1-0.31)	After tax saving in costs	$48,162	$48,162	$48,162	$48,162	$48,162	$48,162
	I	After tax Salvage value of new press						$32,878
	J=D+H+I	Total Cash Inflow	$57,885	$67,683	$62,965	$60,165	$56,744	$89,612	SUM
	K=J/(1.132^N)	Present Value of Cash Inflow	$51,135	$52,818	$43,407	$36,640	$30,527	$42,588	$257,116
	PV	Sum of Present Value of Cash inflows	$257,116
		Initial Outlay:
		Cost of new system	($310,000)
		After tax cash flow on salvage of existing Press	$27,278
	I	Net Initial Cash Flow	($282,722)
	NPV=PV+I	Net Present value	-$25,606	(257116-282722)
		Year	0	1	2	3	4	5	6
		Net Cash Flow	($282,722)	$57,885	$67,683	$62,965	$60,165	$56,744	$89,612
	IRR	Internal Rate of Return (Using IRR function of excel)	10.01%
	MIRR	Using MIRR function of excel	11.42%