A firm is considering an investment in a new machine with a price of $18.18 mill

Question

A firm is considering an investment in a new machine with a price of $18.18 million to replace its existing machine. The current machine has a book value of $6.18 million and a market value of $4.68 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 $6.88 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 $268,000 in net working capital The required return on the investment is 11 percent, and the tax rate is 39 percent. Assume the company uses straight-line depreciation. What is the NPV of the decision to purchase a new machine? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in dollars, not millions of dollars, e.g, 1,234,567.) NPV What is the IRR of the decision to purchase a new machine? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) 11 What is the NPV of the decision to keep the old machine? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. A negative answer should be indicated by a minus sign.) NPV What is the IRR of the decision to keep the old machine? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. A negative answer should be indicated by a minus sign.) 11

Explanation / Answer

New Machine: Initial Cash Outlay 18180000+268000         -1,84,48,000 Operating Expense              68,80,000 Depreciation 18180000/4              45,45,000 EBT 6880000-4545000              23,35,000 Tax 2335000*0.39                9,10,650 Net Income 2335000-910650              14,24,350 OCF 1424350+4545000              59,69,350 Cashflow of new machine: Year Amount 0 -18448000 1 5969350 2 5969350 3 5969350 4 6237350 5969350+268000 A NPV new machine $2,48,124 Answer B IRR 11.62% Answer Old Machine: Depreciation 6180000/4              15,45,000 EBT            -15,45,000 Tax 1545000*0.39               -6,02,550 Net Income               -9,42,450 OCF 1545000-942450                6,02,550 Machine            -46,80,000 Tax               -6,02,550 Initial Cash Outlay (-4680000-602550)            -52,82,550 Cashflow of old machine: Year Amount 0 -5282550 1 602550 2 602550 3 602550 4 602550 C NPV -$34,13,171 Answer D IRR -25.38% Answer

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