Question

1. BestUvClass, Inc. has the choice between two types of machines. One costs less but has a shorter life expectancy. The first machine costs $9,000, will last for two years, and produce revenues of $7,750 in the first year of operation. Operating costs will be 27 percent of revenues and the machine will be depreciated using the 3-Year MACRS schedule. The machine can be sold at the end of two years for $2,000. The initial change in net working capital will be $465. Subsequently, the change in net working capital will be 6% of the change in revenues for the next year. The cost of the first machine is expected to increase by 10 percent per year for the foreseeable future. For replacement chains, assume that the salvage value of the first machine will increase by 10 percent per year, and and initial net working capital will increase by 6 percent per year.

   The second machine will last for four years, cost $12,000, be depreciated using the 3-Year MACRS schedule, and produce revenues of $6,000 in its first year of operation. Operating costs will be 24 percent of revenues. The change in net working capital will be 4% of the change in revenues for the next year. The second machine can be sold for $500 at the end of the project's life.

   Annual revenue inflation for both projects is expected to be 6 percent. The firm's cost of capital is 14.50 percent, and its marginal tax rate is 24 percent.

   1. What are the NPVs for both projects without any consideration of replacement?

   2. Construct replacement chains for these two machines.

   3. Which machine should be selected? Why?

Have to calculate using an excel workbook.

Answer 1

Based on the given data, pls find below workings:

- Have considered 6% inflation trend in the costs;

Based on the below workings, NPV incase of First Machine is $ 1754 and NPV incase of Second Machine is $ 965, with out considering Replacement option;

Based on the Replacement chain option, the NPV of First Machine seems to be $ 743, which is lower than the NPV of Second Machine;

Based on this, it is feasible and it is recommeded to go for Second Machine, if the span of operations requirement is four years;

SHOW FORMULA Option: