Drake Enterprises is a publicly traded firm that manufactures panels for vans. T

Question

Drake Enterprises is a publicly traded firm that manufactures panels for vans. The business is profitable and demand has been increasing. One of the main machines at the company is dated and the company is evaluating whether to replace it. The new machine would cost $750,000 to purchase plus $90,000 in installation and shipping costs. The machine would have a useful life of six years and would be depreciated down to zero on a straight line basis. As a result of the new machine, revenues will increase by $185,000 per year over its six year life, and the machine will also produce cost savings of $95,000 per year. There will be extra inventory needed for the new machine; this is expected to be $60,000. Accounts payable will increase as a result of the new machine as will accounts receivable, by $40,000 and $50,000 respectively. These figures are expected to remain constant until the end of the project. The new machine will require the use of an extra storage garage; the firm has an extra garage but it is being rented out at the moment for $50,000 a year, but would become used by the project if the project was adopted. The machine will require a full maintenance overhaul at the end of three years; this is expected to cost $50,000. A mechanic that already works for the company will be assigned to maintain the new machine; his salary is $30,000 a year. The company will have to hire someone to replace the mechanic. The old machine, which has a book value of $150,000 and three years of life left, will be sold if the project is accepted for $100,000. It is expected that the new machine will be sold at the end of the project for $60,000. The company faces a tax rate of 30% and a cost of capital of 12%. Calculate the breakeven point, NPV, and IRR. Should Drake Enterprises buy the new machine?

Explanation / Answer

Soln : Please refer the table, where we have mentioned and briefed all revenues and cost:

We cab see here the Breakeven in 2nd year and NPV = $59387.26

Drake enterprises should buy the machine as NPV seems to be positive and IRR = 124%

Year 0 1 2 3 4 5 6 Initial cost -750000 Installation cost -90000 Increase in revenue 185000 185000 185000 185000 185000 185000 Cost savings 95000 95000 95000 95000 95000 95000 Accounts receivable 50000 50000 50000 50000 50000 50000 Total -840000 330000 330000 330000 330000 330000 330000 Cost Accounts payable 40000 40000 40000 40000 40000 Extra inventory 60000 60000 60000 60000 60000 60000 Extragarage cost 50000 50000 50000 50000 50000 50000 Maintenance cost 50000 Salary 30000 30000 30000 30000 30000 30000 Depreciation -125000 125000 125000 125000 125000 125000 Total cost 55000 265000 355000 305000 305000 305000 Loss old machine sale 50000 Salvage value of new machine 60000 Net Value -890000 275000 65000 -25000 25000 25000 85000 Tax @ 30% -267000 82500 19500 -7500 7500 7500 25500 Final profit after tax -623000 192500 45500 -17500 17500 17500 59500

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