In: Finance
A company is considering replacing one of the old machines used in the manufacturing process. The machine was purchased 2 years ago for $500,000. This machine is being depreciated on a straight-line basis, and it has 4 yrs of remaining life. When this machine was purchased 2 yrs ago, it was to have zero salvage value at the end of 6 yrs. Currently , this machine has a market value of $250,000. The company intends to keep this old machine as spare if the replacement happens. The current revenue generated by this machine is $250,000 and the cost of operating the machine is $175,000 annually.
The replacement machine will cost of $860,000 and $40,000 for shipping. The new machine falls into 3-yr MACRS (33% , 45%, 15 % and 7%). The replacement machine would permit an output expansion, so sales will become $350,000 per yr. Even so, the new machine would cause operating expenses to become $95,000 per year. The new machine would require inventories to be increased by $65,000 , accounts payable increase by $9000. The replacement project life is 5yrs. The new machine can be sold at the end of its projects life for $45,000 while the old machine will not have any value at the end of its 5th year. Tax rate is 40%, and its cost of capital is 12%.
What is the initial investment CF0?
What is cash flow CF1 to be used in NPV calculations?
1)Increase in net working capital = Increase in inventory - Increase in accounts payable
= 65000 - 9000
= 56000
Capitalized cost of machine = 860000 +40000 = 900000
since the old machine will not be sold if replaced there will be no cash outflow .
CF0 = capitalized cost + working capital investment
= 900000 +56000
= $ 956000
b)
Increase in revenue [350000-250000] | 100000 |
Decrease in operating cost [175000- 95000] | 80000 |
increase in expense | |
Depreciation on replaced machine [900000*.33] | (297000) |
Depreciation on old machine [500000/6] | (83333.33) |
Income before tax | (200333.33) |
Tax [-200333.33*.40] | 80133.33 |
Net income | 120200 |
depreciation [297000+83333.33] | 380333.33 |
Cash flow for year 1[CF1] | 500533.33 |