Question

A firm is considering an investment in a new machine with a price of $17.5 million to replace its existing machine. The current machine has a book value of $7.2 million and a market value of $5.9 million. The new machine is expected to have a 4-year life, and the old machine has four years left in which it can be used. If the firm replaces the old machine with the new machine, it expects to save $7.2 million in operating costs each year over the next four years. Both machines will have no salvage value in four years. If the firm purchases the new machine, it will also need an investment of $430,000 in net working capital. The required return on the investment is 10 percent and the tax rate is 23 percent. The company uses straight-line depreciation.

What is the NPV of the decision to purchase a new machine? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to 2 decimal places, e.g., 1,234,567.89.)

What is the IRR of the decision to purchase a new machine? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

What is the NPV of the decision to purchase the old machine? (A negative amount should be indicated by a minus sign. Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to 2 decimal places, e.g., 1,234,567.89.)

What is the IRR of the decision to purchase the old machine? (A negative amount should be indicated by a minus sign. Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. )

Answer 1

		Present Value (PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate=required return=10%=0.1
		N=Year of Cash Flow
		OLD MACHINE
	A	Opportunity cost of continuing with old machine(not selling)	$5,900,000
	B	Current book value	$7,200,000
	C=B/4	Annual depreciation	$1,800,000
	D=C*0.23	Annual Depreciation tax shield	$414,000
		CASH FLOW
	N	Year	0	1	2	3	4
	E	Cash flow	($5,900,000)	$414,000	$414,000	$414,000	$414,000	SUM
	F=E/(1.1^N)	Present Value of cash flow	($5,900,000)	$376,363.64	$342,148.76	$311,044.33	$282,767.57	($4,587,676)
		NPV(Net present Value)	($4,587,676)
		IRR (Internal Rate of Return)	-36.71%	(Using IRR function over the cash flow)
		NEW MACHINE
	G	Cost of new machine	$17,500,000
	H=G-A	Net Investment after selling old machine	$11,600,000
	I	Annual savings in operating costs(Before tax)	$7,200,000
	X=I*(1-0.23)	Annual after tax savings in cost	$5,544,000
	J=G/4	Annual depreciation of new machine	$4,375,000
	K	Annual depreciation of old machine	$1,800,000
	L=J-K	Additional annual depreciation if new machine is purchased	$2,575,000
	Y=L*0.23	Annual depreciation tax shield	$592,250
	Z=X+Y	Annual additional operating cash flow	$6,136,250
		CASH FLOW
	N	Year	0	1	2	3	4
	M	Net cash Flow	($11,600,000)	$6,136,250	$6,136,250	$6,136,250	$6,136,250	SUM
	PV=M/(1.1^N)	Present Value of net cash flow	($11,600,000)	$5,578,409.09	$5,071,280.99	$4,610,255.45	$4,191,141.32	$7,851,087
		NPV(Net present Value)	$7,851,087
		IRR (Internal Rate of Return)	38.54%	(Using IRR function over the cash flow)