George\'s is considering the purchase of a new machine to replace one that was b

Question

George's is considering the purchase of a new machine to replace one that was bought 2 years ago. The new machine will cost $52, 000 installed and will require a $2000 increases in inventory and a $1500 increase in accounts payble. Both machines will be depreciated on the 3 year schedule (. 33,. 45,. 15,. 07). The old machine can be sold now for $20, 000 or if maintained for three more years it will have a market value then of $5000. It cost $41, 000 when it was new. The new machine will provide revenues of $60000 and expenses of $30, 000 each of the three years of its economic life. It should then have a market value of $10, 000. The old machine would provide revenues of $40, 000 and expenses of $30, 000 for each of the next three years also. If the company has an 18% cost of capital is the project acceptable. Show the initial investment, cashflows and the terminal value, as wll as the NPV or IRR and your decision.

Explanation / Answer

Note: The tax rate applicable is not given in the problem. Hence, the effect of tax on income, depreciation and salvage values cannot be found out. The workings are with '0' tax rate.

Workings for depreciation:

Since this is a replacement project the incremental cash flows are to be calculated: Incremental new investment @ t=0 cost of the new machine 52000 increase in nwc (2000-1500) 500 salvage of the old machine -20000 tax on gain on sale of old machine (20000-9020)* tax rate - not given 0 32500 incremental operating cash flows: (t1 to t3) 1 2 3 net revenue from the new machine 30000 30000 30000 less net revenue of the old machine -10000 -10000 -10000 net increase in operating revenue 20000 20000 20000 depreciation of new machine 17160 23400 7800 depreciation of old machine -6150 -2870 0 net increase in depreciation 11010 20530 7800 net change in income before taxes 8990 -530 12200 tax @ ….% (not given) 0 0 0 net change in income after taxes 8990 -530 12200 add net increase in depreciation 11010 20530 7800 Incremental operating cash flows 20000 20000 20000 pvif@18% 0.8475 0.7369 0.6408 pv 16949 14738 12816 total pv 44504 Terminal year cash flows release of net working capital 500 salvage value of new equipment 10000 tax on gain (10000-3640)*tax rate- not given 0 net cash from salvage of new machine 10000 Salvage value of old equipment 5000 tax on gain (5000-0)*tax rate-not given 0 net cash from sale of old machine-given up 5000 incremental cash from salvage value 5000 incremental cash inflow in the terminal year 5500 pvif@18% 0.6408 pv 3524 NPV of the replacement project: pv of operational cash inflows 44504 pv of terminal cash inflows 3524 total pv of cash inclows 48028 initial investment -32500 NPV 15528 IRR of the project 1 2 3 incremental after tax cash inflows 20000 20000 25500 pvif@35% 0.7407 0.5487 0.4064 pv 14815 10974 10364 36153 . pvif@40% 0.7143 0.5102 0.3644 pv 14286 10204 9293 33783 pvif@45% 0.6897 0.4756 0.3280 pv 13793 9512 8364 31670 IRR = 45 - *5(830/2113) = 43.04%

Related Questions

Navigate

• Browse (All)
• Browse G
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.