XYZ would like to purchase a new machine. It will cost $50,000. Shipping and ins
ID: 2784523 • Letter: X
Question
XYZ would like to purchase a new machine. It will cost $50,000. Shipping and installation charges for the equipment are expected to total $5,000. This equipment will be depreciated using straight line for its 5 year economic life to an estimated salvage value of zero. In order to use this equipment, XYZ estimates it will have to add $7,000 initially to its net working capital. If the machine is purchased, it will replace a machine with a book value of $10,000, the old machine can be sold for $25,000. During the first year of operations, the company expects total revenues to increase by $50,000, and from years 2 to 5 increase by $60,000 per year. The incremental operating expense is expected to be $10,000 in the first year and increase each year by 5%. The marginal tax rate is 40%. If the cost of capital is 12%, using your initial outlay and yearly cash flows, calculate NPV and IRR.
Explanation / Answer
Fixed Assets with installation cost
$ 55,000
Period
5 Years
Depreciation per year
$ 11,000
Working Capital
$ 7,000
Tax Rate
40%
Discount Rate
12.0%
Book Value of Old Asset
$ 10,000
Incremental Depreciation
$ 9,000
Calculation of NPV using Incremental Cash Flow Approach:
Particulars
0
1
2
3
4
5
Fixed Assets
$ -55,000
Working Capital
$ -7,000
Sale of Old Machine
$ 25,000
Incremental Revenue
$ 50,000
$ 60,000
$ 60,000
$ 60,000
$ 60,000
Incremental Expense
$ 10,000
$ 10,500
$ 11,025
$ 11,576
$ 12,155
EBITDA
$ 40,000
$ 49,500
$ 48,975
$ 48,424
$ 47,845
Less: Incremental Depreciation
$ 9,000
$ 9,000
$ 9,000
$ 9,000
$ 9,000
EBIT
$ 31,000
$ 40,500
$ 39,975
$ 39,424
$ 38,845
Less: Tax @40%
$ 12,400
$ 16,200
$ 15,990
$ 15,770
$ 15,538
PAT
$ 18,600
$ 24,300
$ 23,985
$ 23,654
$ 23,307
Cash Flows After Tax
$ 27,600
$ 33,300
$ 32,985
$ 32,654
$ 32,307
Recovery of Working Capital
$ 7,000
Incremental After tax cash flows
$ -37,000
$ 27,600
$ 33,300
$ 32,985
$ 32,654
$ 39,307
PVF@12%
1.000
0.893
0.797
0.712
0.636
0.567
PV of Cash Flows
$ -37,000
$ 24,643
$ 26,547
$ 23,478
$ 20,752
$ 22,304
NPV
$ 80,724
IRR of the Project is 79%
Fixed Assets with installation cost
$ 55,000
Period
5 Years
Depreciation per year
$ 11,000
Working Capital
$ 7,000
Tax Rate
40%
Discount Rate
12.0%
Book Value of Old Asset
$ 10,000
Incremental Depreciation
$ 9,000
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