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10-14 Otter Outside Gear must decide whether to replace a 10 year old packing machine with...

10-14 Otter Outside Gear must decide whether to replace a 10 year old packing machine with a new one that costs. $142,600. Replacing the old machine will increase net operating income (excluding depreciation) from $75,000 to $105,000. It will decrease NWC by $16,000. The new machine falls in the MACRS 5-year class. If the new machine is purchased, it will be sold in six years for $20,000; whereas, if the old machine is kept, it will have no salvage value in six years. The old machine has a current market value of $7,260, and although its current book value is $6000, in one year the old machine's book value will be zero. The firm's marginal tax rate is 35%, and its required rate of return is 10%. Should the new packing machine be purchased? Use NPV, IRR and MIRR to make your decision.

Solutions

Expert Solution

cost of new machine -142600
recovery of working capital 16000
after tax selling price of old machine =(7260-6000)*(1-..35) 6819
incremental net cash outflow -119781
selling price of old equipment 7260
book value 6000
gain on sale 1260
tax on gain on sale-35% 441
after tax sale proceeds 7260-441 6819
Year 1 2 3 4 5 6
Cost of equipment 142600 142600 142600 142600 142600 142600
Macrs rate 20% 32% 19.20% 11.52% 11.52% 5.76%
Annual depreciation 28520 45632 27379.2 16427.52 16427.52 8213.76
depreciation on ond equipment 6000 0 0 0 0 0 0
Incremental depreciation 22520 45632 27379.2 16427.52 16427.52 8213.76
annual Incremental operating profit excluding depreciation 105000-75000 30000
Year 0 1 2 3 4 5 6
incremental net cash outflow -119781
annual Incremental operating profit excluding depreciation 30000 30000 30000 30000 30000 30000
less incremental depreciation 22520 45632 27379.2 16427.52 16427.52 8213.76
annual Incremental operating profit 7480 -15632 2620.8 13572.48 13572.48 21786.24
less tax-35% 2618 -5471.2 917.28 4750.368 4750.368 7625.184
after tax incremental profit 4862 -10160.8 1703.52 8822.112 8822.112 14161.06
add incremental depreciation 22520 45632 27379.2 16427.52 16427.52 8213.76
after tax scrap value of equipment =20000*(1-.35) 13000
net operating cash flow = after tax incremental profit+incremental depreciation+after tax scrap value -119781 27382 35471.2 29082.72 25249.63 25249.63 35374.82
present value of net operating cash flow = net operating cash flow/(1+r)^n r = 10% -119781 24892.72727 29315.04132 21850.28 17245.84 15678.03 19968.16
Net present value = sum of present value of net operating cash flow 9169.081
IRR = using IRR function in MS excel =irr(cell reference year 0 net operating cash flow: cell reference year 6 net operating cash flow) 12.57%
MIRR = using MIRR function in MS excel =Mirr(cell reference year 0 net operating cash flow: cell reference year 6 net operating cash flow,finance rate,reinvestment rate) finance rate =10% reinvestment rate =10% 11.36%
Yes machine should be purchased as NPV is greater than zero and IRR and MIRR is more than required rate of return

jeff jeffy answered 2 years ago
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