Question

A firm is considering an investment in a new machine with a price of $18.15 million to replace its existing machine. The current machine has a book value of $6.15 million and a market value of $4.65 million. The new machine is expected to have a four-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 $6.85 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 $265,000 in net working capital. The required return on the investment is 12 percent, and the tax rate is 35 percent. Assume the company uses straight-line depreciation.

What is the NPV of the decision to purchase a new machine? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.) NPV $ 100900.69

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.) IRR 12.26 %

What is the NPV of the decision to keep the old machine? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. A negative answer should be indicated by a minus sign.) NPV $ ????

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

(can't figure out NPV and IRR for decision to keep the old machine)

Answer 1

Purchase of new Machine expenses	$18,150,000
Book Value	$          6,150,000
Market Value	$          4,650,000
Net Working Capital	$            265,000
Required return	12%
Tax Rate	35%
Operating Expenses	6,850,000
PVIFA (12%, 4)    (1-(1+r)-n) /r	3.0373
Purchase of New Machine
Initial Outlay = 1815000+265000	18,415,000
Operating Expenses	6,850,000
Depreciation = 18,150,000 / 4	$          4,537,500
Earning Before tax	2,312,500
Tax = EBT x 35%	809,375
Net Income = EBT - Tax	1,503,125
Operating Cash Flow = 6,850,000 - 1,503,125	5,346,875

Year	Cash Flow	PV Factor= 1/(1+R)^n = 1/(1+.12)^n	Cash Flow x PV factor
0	-18,415,000	1.00000	$           -18,415,000
1	5,346,875	0.89286	$               4,773,996
2	5,346,875	0.79719	$               4,262,496
3	5,346,875	0.71178	$               3,805,800
4	5,611,875	0.63552	$               3,566,448
	Net Present Value = Sum of present values		$              -2,006,260
IRR			6.76%

Keep Old Machine
Depreciation = 6,150,000 / 4	1537500
Earning Before tax	-1537500
Tax = EBT x 35%	-538125
Net Income = EBT - Tax	-999375
Operating Cash Flow = 1537500 - 999375	538125
Machine	-4650000
Tax = EBT x 35%	-538125
Total Initial Cash Flow	-5188125

Year	Cash Flow	PV Factor= 1/(1+R)^n = 1/(1+.12)^n	Cash Flow x PV factor
0	-5188125	1.00000	-5188125
1	538125	0.89286	480469
2	538125	0.79719	428990
3	538125	0.71178	383027
4	538125	0.63552	341988
	Net Present Value = Sum of present values		-3553651
IRR			-27.80%