In: Finance
PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $85 million on equipment with an assumed life of 5 years and an assumed salvage value of $10 million for tax purposes. The firm uses straight-line depreciation. The old equipment can be sold today for $100 million. A new modem pool can be installed today for $210 million. This will have a 3-year life and will be depreciated to zero using straight-line depreciation. The new equipment will enable the firm to increase sales by $40 million per year and decrease operating costs by $20 million per year. At the end of 3 years, the new equipment will be worthless. Assume the firm’s tax rate is 30% and the discount rate for projects of this sort is 9%.
a. What is the net cash flow at time 0 if the old equipment is replaced? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)
b. What are the incremental cash flows in years (i) 1; (ii) 2; (iii) 3? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)
c. What is the NPV of the replacement project? (Do not round intermediate calculations. Enter the NPV in millions rounded to 2 decimal places.)
d. What is the IRR of the replacement project? (Do not round intermediate calculations. Enter the IRR as a percent rounded to 2 decimal places.)
Depreciation of the old equipment = ($ 85 million - 10 million) / 5 year = $ 15 million per year
Book value of old equipment at time of sale = $ 85 million - 15 million * 2 = $ 55 million
Calculation of the net proceeds after tax from sale old equipment :-
Sale proceeds from old equipment | $ 100 million |
Less- Book value of old equipment at time of sale | $ 55 million |
Gain on sale of old equipment | $ 45 million |
Less- Tax on gain @30% | $ 13.5 million |
Net proceeds from sale of old equipment after tax | $ 86.5 million |
a) Net cash flow at year 0
Purchase of new modem pool | $ 210 million |
ADD- Net proceeds from sale of old machine | $ 86.5 million |
Net Cash flow at year 0 | $ 123.5 million |
b) Calculaion of cash inflows for year 1,2,3
Depreciation on new equipment = 210 million /3 year = 70 million
Particulars | Year 1 | Year 2 | Year 3 |
Increase in sales | $ 40 million | $ 40 million | $ 40 million |
Add- decrease in operating cost | $ 20 million | $ 20 million | $ 20 million |
Net increase in profit before depreciation | $ 60 million | $ 60 million | $ 60 million |
Less- Increase in depreciation (70 million - 15 million) | $ 55 million | $ 55 million | $ 55 million |
Incremental profit before tax | $ 5 million | $ 5 million | $ 5 million |
Less- Tax@30% | $ 1.5 million | $ 1.5 million | $ 1.5 million |
Incremental profit after tax | $ 3.5 million | $ 3.5 million | $ 3.5 million |
Add- Increase in depreciation | $ 55 million | $ 55 million | $ 55 million |
Net cash inflows per year | $ 58.5 million | $ 58.5 million | $ 58.5 million |
c) NPV :-
D) IRR :-