Question

King Fisher Aviation is considering an investment in a new technology for a drone project with a price of $16 million. Their current technology has a book value of $5 million and a market value of $5 million. The new technology is expected to have a five (5) year life, and the old technology has three (3) years left in which it can be expected to be used. If the firm replaces the old technology with the new technology it expects to save $5.7 million in operating costs each year over the next four years. If the firm purchases the new technology, it will also need an investment of $300,000 in net working capital. The required return on the investment is 12 percent, and the tax rate is 39 percent.

What are the NPV and IRR of the decision to replace the old technology?

Fill in the values in the spreadsheet.

	Cost of new machine	$        16,000,000
	Old machine book value	$          5,000,000
	Old machine market value	$          5,000,000
	Years of operation	5
	Saved operating costs	$          5,700,000
	Net working capital	$             300,000
	Required return	12%
	Tax rate	39%
	*Depreciation straight-line
		Buy new machine		Keep old machine		Incremental analysis
	Initial cash outlay:
	Purchase new machine
	Net working capital
	Sell (buy) old machine
	Taxes on old machine
	Total
	Incremental cash flows
	Operating expense
	Depreciation
	EBT
	Taxes
	Net income
	OCF
	Year	Cash flow		Cash flow		Cash flow
	0
	1
	2
	3
	4
	NPV
	IRR

Answer 1