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9) Global company is considering replacing one of its equipment with a more efficient one. The...

9) Global company is considering replacing one of its equipment with a more efficient one. The old machine has a book value of $60,000 and a remaining useful life of 5 years. It can sell the old machine now for $ 265,000. The old machine is being depreciated by 120,000 per year straight line. The new machine has a purchase price of $ 1,175,000 an estimated useful life and 5 years MACRS class life and salvage value of $145,000. Annual economic savings is $255,000 if new machine is installed. Taxes 40% and WACC is 12%.

a. Calculate the initial cash flow at time 0, which is today.

b. Calculate the cash flows for years 1 thru 5.

c. Calculate the terminal value at year 5

d. Calculate the NPV and IRR of the project and make a decision on whether the company should accept or reject the investment and why?

Solutions

Expert Solution

a) After tax value of old machine = 265000-(265000-60000)*40%
= 183000
Cash outflow today = 1,175,000-183,000
= 992000
b) Calculation of Depreciation
Year 1 2 3 4 5 6 (WDV )  
Rate 20% 32% 19.20% 11.52% 11.52% 5.72%
Cost 1,175,000 1,175,000 1,175,000 1,175,000 1,175,000 1,175,000
Dep 235000 376000 225600 135360 135360 67210
Calculation of cash flow
Year 1 2 3 4 5 total
saving 255000 255000 255000 255000 255000
dep 235000 376000 225600 135360 135360
profit before tax 20000 -121000 29400 119640 119640
tax 8000 -48400 11760 47856 47856
profit after tax 12000 -72600 17640 71784 71784
Cash flow 247000 303400 243240 207144 207144
PVF @ 12% 0.8929 0.7972 0.7118 0.6355 0.5674
Discounted CF 220535.7 241868.6 173133.4 131643.8 117539.1 884720.6
c)
WDV at year 5 (dep for year 6) = 67210
After tax salvage value of machine after 5 years = 145000-(145000-67210)*40%
113884
PV of salvage value today = 113884*0.5674
= 64617.78
d) NPV = Dicounted CF+PV of terminal CF-cash outflow At year 0
= 884720.6+64617.78-992000
= -42661.62
IRR = 10.2673%
Company should reject the project as NPV is negative or IRR is less than WACC

jeff jeffy answered 1 year ago
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