Question

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.

Answer 1

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