Question

The CSI Corporation is looking to replace an existing printing press with one of two newer models that are more efficient. The current press is three years old, cost 32,000 and is being depreciated under MACRS using a 5-year recovery period. The first alternative under consideration, Printing Press A, cost $40,000 to purchase and $8,000 to install. It has a 5 year usable life and will be depreciated under MACRS using a 5-year recovery period. The second alternative, press B cost $54,000 to purchase and $6,000 to install. It also has a 5 year usable life and will be depreciated under MACRS using a 5 year recovery period. The purchase of press A would result in a $4,000 increase in net working capital, and the purchase of Press B would increase net working capital by $6,000. The projected Earnings before depreciation interest and taxes for each alternative is presented below.

Year	Press A	Press B	Existing press
1	25,000	22,000	14,000
2	25,000	24,000	14,000
3	25,000	26,000	14,000
4	25,000	28,000	14,000
5	25,000	28,000	14,000

The existing press can currently be sold for $18,000 before taxes. At the end of the 5 years the existing press can be sold for $1,000 before taxes. Press A can be sold to net $12,000 before taxes and press B can be sold to net $20,000 before taxes at the end of the 5 year period. The firm is subject to a 40% tax rate.

The company has $100M of debt outstanding with a yield-to-maturity of 8%, and has $150M of equity outstanding with a beta of 0.9. The expected market return is 13% and the risk-free rate is 5%.

please post the answer with the excel sheets included

Answer 1

Based on the given information, firstly we need to identify the Weighted Average Cost of Capital (WACC);

WACC in general is the total of cost of Debt and Cost of Equity applied with their respective weights of the overall Debt-Eqtuiy structure of the Compnay.

The below calculation on WACC:

Based on this calculation, WACC is 9.24%;

With the other given information, pls find below the three tables with three scenarios:

Table 1: With the details and NPV/IRR/Payback calculations for option of Replacing the exising Press with Press A;

Table 2: With the details and NPV/IRR/Payback calculations for option of Replacing the exising Press with Press B;

Table 3: Option of not to replace and continue with the existing Press for next five years;

Based on the above, it can be concluded that the company can go for replacing teh existing Press with Press A; since the NPV is the highest among all the three; The next best option shall be to continue with the existing press rather than replacing the same with Press B; Option for Press A is optimal as per NPV, IRR as well as the Payback period as comaped to Press B option:

Computation:

Payback Period: Computation of Pay Back Period: Here, the period is computed for each project, based on cumulative discounted cash flows: If the cumulative value is less than or equal to zero, the period is considered as 12 months (it means that the net cumulative cash flow has not yet paid back the initial invesment); Once the value turns postive in a particular year, the period for such year is observed at a proportion of actual discounted cash flow to the cumulative CF; This gives the period less than 12 months in such year; Once this is computed, total of all the years is taken and divided by 12, to arrive at the Payback period in no.of years.

Net Present Value:

Computation of Net Present Value (NPV) based on the Disounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) = 1/(1+9.24%) = 0.9154; Year 2 = Year 1 factor/(1+discounting factor %) = 0.9154/(1+9.24%) = 0.8380 and so on;

Next, the cashflows need to be multplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows

IRR: Computation of IRR: This can be computed using formula in Excel = IRR("range of cashflows", discounting factor%); Here, the cash flows means normal cash flows, not the discounted cash flows.