The great tech company is considering replacing one of its machines with a more
ID: 2806422 • Letter: T
Question
The great tech company is considering replacing one of its machines with a more efficient one. The old machine has a book value of $60,000 and a remaining useful life of 5 years. It can sell the old machine now for $ 265,000. The old machine is being depreciated by 120,000 per year straight line. The new machine has a purchase price of $ 1,175,000 an estimated useful life and 5 years MACRS class life and salvage value of $145,000. Annual economic savings is $255,000 if new machine is installed. Taxes 35% and WACC is 12. a. Calculate the NPV and IRR of the project and make a decision. b. If expected life of existing machine decreased what effect does this have on the cash flow, discuss only? c. If R&D were $30,000, what effect on NPV? Discuss only.
Explanation / Answer
a) NPV and IRR of the project
Working notes:
1) Initial investment
2) After tax sale old machine
3) After tax salvage value new machine
No, Great Tech should not replace the old machine right now as the new machine has a negative NPV and the IRR is less than the cost of capital.
b) If the expected life of the existing machine decreased, it will not have any effect on the cash flow becuase we are selling the machine right now so the life expectancy after sale will not be of any value.
c) If R&D were $30000, there would be no effect on NPV, becuase R&D is a sunk cost and hecne is not taken into consideration.
0 1 2 3 4 5 Annual savings $2,55,000 $2,55,000 $2,55,000 $2,55,000 $2,55,000 Depreciation $2,35,000 $3,76,000 $2,25,600 $1,35,360 $1,35,360 Operating income $20,000 -$1,21,000 $29,400 $1,19,640 $1,19,640 Tax @35% $7,000 -$42,350 $10,290 $41,874 $41,874 Net income $13,000 -$78,650 $19,110 $77,766 $77,766 Operating cash flows $2,48,000 $2,97,350 $2,44,710 $2,13,126 $2,13,126 Initial investment -$9,81,750 After tax salvage value $1,17,938 Net cash flows -$9,81,750 $2,48,000 $2,97,350 $2,44,710 $2,13,126 $3,31,064 cost of capital $1 $0.893 $0.797 $0.712 $0.636 $0.567 PV of cash flows -$9,81,750 $2,21,429 $2,37,046 $1,74,180 $1,35,445 $1,87,855 NPV -$25,796 IRR 11%Related Questions
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