A firm is considering an investment in a new machine with a price of $18.08 mill

Question

A firm is considering an investment in a new machine with a price of $18.08 million to replace its existing machine. The current machine has a book value of $6.08 million and a market value of S4.58 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 $6.78 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 $258,000 in net working capital. The required return on the investment is 9 percent, and the tax rate is 40 percent. What is the NPV of the decision to purchase a new machine What is the IRR of the decision to purchase a new machine What is the NPV of the decision to purchase the old machine What is the IRR of the decision to purchase the old machine

Explanation / Answer

b)

Compute IRR using excel function.

IRR = IRR(-13758000,5876000,5876000,5876000,6030800)

= 25.74%.

2)

a)

a) Computation of NPV for purchase of new machine 0 1 2 3 4 Initial investment -18080000 Working capital requirement -258000 258000 Sale of old machine 4580000 Saving in operating costs 6780000 6780000 6780000 6780000 Less: Depreciation -4520000 -4520000 -4520000 -4520000 Cash Flows before taxes 2260000 2260000 2260000 2518000 Tax @0.40 904000 904000 904000 1007200 Cash Flow after tax 1356000 1356000 1356000 1510800 Add: Depreciation 4520000 4520000 4520000 4520000 Cash Flows -13758000 5876000 5876000 5876000 6030800 Discount @0.09 1 0.91743119 0.84168 0.77218348 0.708425 Present value of cash flows -13758000 5390825.69 4945712 4537350.13 4272371 Net Present Value 5388258.22

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