Question

QuattroMarti Company (QMC), a clothing and accessories producing firm, is planning to purchase a new and more efficient packing and labelling equipment to replace the old one that was bought and installed five years ago for $200,000(including shipping and installation). The old equipment has been depreciated using straight-line method with an expected useful life of 10 years and zero salvage value. QMC management believes they can sell the old equipment for $120,000, which is its current market value. The new equipment, which QMC is considering to purchase, has price $280,000 with extra $20,000 shipping and installation cost. The new equipment falls into the MACRS 5-year class. The management expects to sell the new equipment for $140,000 at the end of the fifth year. The new equipment, due to its higher efficiency, is expected to reduce operating cost by of $20,000 and to increase production and sales by $130,000 per year, both before taxes. QMC’s marginal tax rate is 40 percent and its cost of capital is 16%. According to the approved capital budgeting guidelines of the company, QMC uses both NPV and MIRR to evaluate investment projects.

Answer 1

Book Value of old equipment = ($200,000 / 10) × 5

= $100,000

Book Value of old equipment is $100,000.

Market value of old equipment = $120,000

After tax net proceed from sale = $100,000 + ($120,000 - $100,000) × (1 - 40%)

= $100,000 + $12,000

= $112,000

Net proceed after tax from sale of old equipment is $112,000.

Increase in before tax profit = $130,000 + $20,000

= $150,000

Increase in before tax profit is $150,000.

Total cost of new equipment = $280,000 + $20,000

= $300,000

Total cost of new equipment including shipping and installment cost is $300,000.

Now, NPV of project is calculated in excel and screen shot provided below:

NPV of project is $228,175.34 and MIRR of project is .8953%.

Since, NPV of proect is a positive value, so project should be accepted.