Question

Hat Co. is considering the replacement of its old, fully depreciated hat press. Two new presses are available.  A steam press costs $200,000, has a five-year expected life, and will be able to make twice as many hats as the old machine, yielding an additional $60,000 in after-tax cash flows. A dry press costs $300,000, has a 7-year expected life, and will generate after-tax cash flows of $63,400 per year. Currently, Hat Co. is valued at $5,000,000 and has $600,000 in debt at 6%. Its tax rate is 20%. The cost of equity for similar companies is 15%.

Calculate Hat Co.'s after-tax weighted average cost of capital.
What is the NPV (after-tax) and discounted breakeven for the steam and dry presses?
Which press should Hat Co. select?

Answer 1

	Cost	Weight
Equity	15%	$                                  50,00,000	$                         7,50,000
Debt	4.80%	$                                    6,00,000	$                             28,800
		$                                  56,00,000	$                         7,78,800
WACC	13.91%
	Steam press	Dry press
Initial costs	$                                        2,00,000	$                                    3,00,000
Annual after tax cashflows	$                                           60,000	$                                       63,400
PV factor @ 13.91%
For 5 Years	3.44
For 7 Years		₹ 4.30
PV of after tax cashflows	$                                  2,06,431.20	$                              2,72,627.82
NPV	$                                        6,431.20	$                                -27,372.18
Discounted payback period
Steam press
Year	PV of CFAT	Cumulative PV of CFAT
1	$                                      52,673.16	$                                  52,673.16
2	$                                      46,241.04	$                                  98,914.20
3	$                                      40,594.36	$                              1,39,508.56
4	$                                      35,637.22	$                              1,75,145.78
5	$                                      31,285.42	$                              2,06,431.20
Discounted payback period =	4+((200000-175145.78)/31285.42)
Discounted payback period =	4.79	Years
Dry press
Year	PV of CFAT	Cumulative PV of CFAT
1	$                                      55,657.98	$                                  55,657.98
2	$                                      48,861.36	$                              1,04,519.34
3	$                                      42,894.71	$                              1,47,414.04
4	$                                      37,656.66	$                              1,85,070.71
5	$                                      33,058.26	$                              2,18,128.97
6	$                                      29,021.39	$                              2,47,150.35
7	$                                      25,477.47	$                              2,72,627.82
Discounted payback period =	More than 7 Years

Hat Co should clearly select Steam Press as NPV is positive and discounted payback period is less than its life.

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