Question

A firm is considering an investment in a new machine with a price of $18.03 million to replace its existing machine. The current machine has a book value of $6.03 million and a market value of $4.53 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 $6.73 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 $253,000 in net working capital. The required return on the investment is 10 percent, and the tax rate is 38 percent. Assume the company uses straight-line depreciation.

Answer 1

Annual Cash flow and NPV IRR of new Machine is calculated in excel and screen shot provided below:

B19 X-/ fr || -NPV(10%,C17:F17)+817 1 Year 2 initial Investment 3 Working capita 4 5 Depreciation rate 6 Annual Depreciation 0 ($18,030,000) ($253,000) 1 4 25.00% 25.00% 25.00% 25.00% $4,507,500 $4,507,500 $4,507,500 $4,507,500 $6,730,000 $6,730,000$6,730,000 $6,730,000 $2,222,500 $2,222,500 $2,222,500 $2,222,500 8 Annual Cost Saving 10 Cost saving minus depreciation 11 Taxable Income 12 13 Tax (0.38% 14 Net profit 15 16 Return of Working capital 17 Total Cash flow 18 19 Net Present Value 20 Internal Rate of return 21 $2,222,500 $2,222,500 $2,222,500$2,222,500 $844,550 $844,550 $844,550 $844,550 $1,377,950 $1,377,950$1,377,950 $1,377,950 $253,000 ($18,283,000)| S5.885.450 $5.885.450 | $5.885.450 | Ś6.138.450 $545,887.00 11.36%

NPV of new machine is $545,887 and IRR is 11.36%.

Since, NPV of new machine is a positive value, so project should be accepted.