Question

Veridian Dynamics is considering the purchase of a new cloning machine, which will cost $390 million plus an additional $10 million to ship and install. The new machine will replace the existing machine, which has zero book value and could be sold today for $40 million. The new machine will have a 4 year useful life and willl be depreciated to zero using the straight line method. The machine will require $10 million worth of spare parts to be purchased initially and held in inventory for the next 4 years to make sure the machine operates smoothly. It is assumed that these spare parts will be sold at the end of 4 years and the entire $10 million will be recaptured.

The new machine will increase sales by $220 million per year, increase cost of goods sold by $110 million per year, and decrease operating expenses by $10 million per year over the next 4 years. Veridian Dynamics expects to sell the new machine for $80 million at the end of 4 years. Veridian Dynamic's income tax rate is 35% and its cost of capital is 14%.

What is the Net Present Value of this project?

Answer 1

	Initial cash flow
	Cost of machine			-390
	Installation and transport cost			-10
	Salvage value of old machine			40
	Tax on salvage value of old machine		40*35%	-14
	Spare parts			-10
				-384
	Year		0	1	2	3	4
	Initial Investment		-384
	Increase in Sales			220	220	220	220
	Increase in COGS			110	110	110	110
	Decrease in Operating expenses			10	10	10	10
	EBIT		(i)	120	120	120	120
	-Taxes		(ii)	42	42	42	42
	+New Depreciation		(390+10)/4 =(iii)	100	100	100	100
	-Old Depreciation			0	0	0	0
			(i-ii+iii)	178	178	178	178
	+ Recapture Of NWC						10
	Post tax salvage value of new machine	(80*(1-35%))					52
	TOTAL FCF		-384	178	178	178	240
	PV factor @ 13%		1	0.884956	0.783147	0.69305	0.613319
	PV of FCF		-384	157.5221	139.4001	123.3629	147.1965
	NPV = Sum of PV of FCF		183.4817