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 your recommendations on the investment project? Explain your reasoning?

What are your recommendations for investment in the new technology?

Answer 1

Please

	Linkage	Buy new machine	Keep old machine	incremental analysis
Initial cash outlay
purchase new machine	A	(16,000,000)	-	(16,000,000)
net working capital	B	(300,000)	-	(300,000)
sell old machine	C	-	5,000,000	5,000,000
taxes on old machine	D = (C - 5) x 39%	-	-	-
total	E = A + B + C + D	(16,300,000)	5,000,000	(11,300,000)
incremental cash flow
operating expense		5,700,000	-	5,700,000
depreciation		(3,200,000)	(1,666,667)	(1,533,333)
EBT		2,500,000	(1,666,667)	4,166,667
less tax -29%		975,000	(650,000)	1,625,000
Net income		1,525,000	(2,316,667)	2,541,667
OCF = net income+ depreciation		4,725,000	(650,000)	4,075,000

Year	Buy new machine	Keep old machine	incremental analysis
0	(16,300,000)	5,000,000	(11,300,000)
1	4,725,000	(650,000)	4,075,000
2	4,725,000	(650,000)	4,075,000
3	4,725,000	(650,000)	4,075,000
4	4,725,000	(650,000)	4,075,000
NPV =using NPV function in Excel where r =12%	(1,948,524)	3,025,723	1,077,199
IRR = Using IRR function in MS excel	6.19%	-21.85%	16.45%

What are your recommendations on the investment project? Explain your reasoning?

I will recommend the replacement project as incremental cash flows under replacement project, has positive NPV and IRR > required rate of return.

What are your recommendations for investment in the new technology?

Investment in the new technology on the standalone basis is a negative NPV project. it has IRR < required rate of return. hence, I willnot recommend the investment in the new technology.