The ABD company is considering replacing the latex molding machine it uses to fa

Question

The ABD company is considering replacing the latex molding machine it uses to fabricate rubber boots with a newer, more efficient model. The old machine has a book value of $450,000 and a remaining useful life of 5 years. ABD can sell it now to another firm $153,000. The old machine is being depreciated on a straight line basis over the next 5 years to a zero salvage value. If used for three more years, it should sell for $50,000. The new machine has a purchase price of $775,000. An additional $25,000 would be spent in shipping and installation. The machine is expected to have a market value of $250,000 in three years. In addition, a consultant was paid $15,000 to estimate the cost benefits, future market value and identify the best manufacturer of this replacement machine. The machine is classified as a 5 year class MACRS asset for depreciation purposes. The applicable depreciation rates are: 20%, 32%, 19.2%, 11.52%, 11.52% and 5.76% respectively. The new machine is not only more efficient, requiring less electricity, labor and repair costs, reducing expenses by $80,000 per year, but most important it can produce different colored boots that are expected to increase sales by $120,000 a year.

This project is expected to last only 3 more years. The firm’s marginal tax rate is 40% and its WACC is 12%. (use the back of the first page if you need more room too).

                Two other coworkers have already calculated the NPVs for the other states of nature’ (scenarios). Scenario A has a 40% chance of occurring and a NPV of $50,000. Scenario B has a 25% chance of occurring and has a NPV of $75,000. You are calculating Scenario C and justifying the final decision to accept or reject this investment project.    Please show steps. I am not finding or understanding the revenue expenses or fixed costs

Explanation / Answer

step 1:

step 2:

Now cumulative we need to see the net present value applying the chance of occuring

Since the Net present value is positive the final decision is to accept the project and invest.

Particulars 1 2 3 4 5 sales 120000 120000 120000 120000 120000 save cost 80000 80000 80000 80000 80000 Total sale/benefits 200000 200000 200000 200000 200000 20% 32% 19.2% 11.52% 11.52% Depreciation rate given 160000 256000 153600 92160 92160 (on 800000) Consultant 15000 Profit 25000 -56000 46400 107840 107840 tax40% 10000 -22400 18560 43136 43136 Profit after tax 15000 -33600 27840 64704 64704 Cash flow=profit+depreciation 175000 222400 181440 156864 156864

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