Question

The great tech company is considering replacing one of its machines with a more efficient one. The old machine has a book value of $60,000 and a remaining useful life of 5 years. It can sell the old machine now for $ 265,000. The old machine is being depreciated by 120,000 per year straight line. The new machine has a purchase price of $ 1,175,000 an estimated useful life and 5 years MACRS class life and salvage value of $145,000. Annual economic savings is $255,000 if new machine is installed. Taxes 35% and WACC is 12. Calculate the NPV and IRR of the project and make a decision on accepting the project and why? If expected life of existing machine decreased what effect does this have on the cash flow, discuss only? Please include excel cells and formulas.

Answer 1

The great tech company is considering replacing one of its machines with a more efficient one. The old machine has a book value of $60,000 and a remaining useful life of 5 years. It can sell the old machine now for $ 265,000. The old machine is being depreciated by 120,000 per year straight line. The new machine has a purchase price of $ 1,175,000 an estimated useful life and 5 years MACRS class life and salvage value of $145,000. Annual economic savings is $255,000 if new machine is installed. Taxes 35% and WACC is 12. Calculate the NPV and IRR of the project and make a decision on accepting the project

ans

a)   INCREMENTAL INITIAL INVESTMENT:                          
Cost of the new machine       1175000                  
Less: Salvage value net of tax of the old machine:                          
Sale value   265000                      
Book value   60000                      
Gain on sale   205000                      
Tax at 35% on gain   71750                      
Aftertax cash flow from sale of old machine       193250                  
Incremental initial investment       981750                  
ANNUAL OPERATING CASH FLOWS:   0   1   2   3   4   5  
Annual savings       255000   255000   255000   255000   255000  
Incremental depreciation:                          
Depreciation on the new machine (MACRS 5 Yr)       235000   376000   225600   135360   135360   1107320
Depreciation on old machine       12000   12000   12000   12000   12000  
Incremental depreciation       223000   364000   213600   123360   123360  
Incremental net savings before tax       32000   -109000   41400   131640   131640  
Tax at 35%       11200   -38150   14490   46074   46074  
Incremental net savings after tax       20800   -70850   26910   85566   85566  
Add: Incremental depreciation       223000   364000   213600   123360   123360  
Add: Incremental after tax operating cash flows       243800   293150   240510   208926   208926  
Capital expenditure   981750                   -117938  
Incremental project cash flows   -981750   243800   293150   240510   208926   326864  
PVIF at 12%   1   0.89286   0.79719   0.71178   0.63552   0.56743  
PV at 12%   -981750   217679   233697   171190   132776   185471   -40936
NPV   -40936   Answer                  
WORKING FOR TERMINAL NON OPERATING CASH FLOW:                      
Salvage value of new machine                       145000  
Book value = 1175000-1107320 =                       67680  
Gain on sale                       77320  
Tax at 35% on gain                       27062  
After tax salvage value                       117938  
CALCULATION OF IRR:                          
Incremental project cash flows   -981750   243800   293150   240510   208926   326864  
PVIF at 11%   1   0.90090   0.81162   0.73119   0.65873   0.59345  
PV at 11%   -981750   219640   237927   175859   137626   193978   -16721
PVIF at 10%   1   0.90909   0.82645   0.75131   0.68301   0.62092  
PV at 10%   -981750   221636   242273   180699   142699   202957   8514
IRR lies between 10% and 11%                          
IRR = 10+8514/(8514+16721) = 10.34% (Answer)

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