XYZ would like to purchase a new machine. It will cost $50,000. Shipping and ins

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

0 1 2 3 4 5 Incremental revenue 50000 60000 60000 60000 60000 Incemental operating expense 10000 10500 11025 11576 12155 Depreciation (55000/5) 11000 11000 11000 11000 11000 Incremental operating income 29000 38500 37975 37424 36845 Tax at 40% 11600 15400 15190 14970 14738 Incremental NOPAT 17400 23100 22785 22454 22107 Add: Depreciation 11000 11000 11000 11000 11000 Incremental operating cash flow 28400 34100 33785 33454 33107 Capital expenditure: Cost of new machine including installation 55000 Salvage value of old machine net of tax = 25000-15000*0.40 = -19000 Increase in NWC 7000 -7000 FCF -43000 28400 34100 33785 33454 40107 PVIF at 12% 1.0000 0.8929 0.7972 0.7118 0.6355 0.5674 PV at 12% -43000 25358 27185 24048 21260 22757 NPV $77608 CALCULATION OF IRR: FCF -43000 28400 34100 33785 33454 40107 PVIF at 70% 1 0.5882 0.3460 0.2035 0.1197 0.0704 PV at 70% -43000 16706 11799 6877 4005 2825 -788 PVIF at 68% 1 0.5952 0.3543 0.2109 0.1255 0.0747 PV at 68% -43000 16905 12082 7125 4200 2997 308 IRR lies between 68% and 70% The value of IRR can be found out by simple interpolation as below: IRR = 68+2*308/(788+308) = 68.56%

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