Question

a firm is considering a an investment in a new macjine with a price of $17.1 million to replace its existing machine. The current machine has a book value of $6.7 million and a market value of $5.4 million. The new machine is expected to have a 4-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 $6.95 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 380,000 in net working capital. The required return on the investment is 9 percent and the tax rate is 23 percent. The company uses straight line depraciation

New machine npv

new machine irr

old machine npv

Answer 1

	Buy New Machine	Keep Old Machine
Initial cash outlay:
Purchase new machine	-17100000		-17100000
Net working capital	-380000		-380000
Sell (buy) old machine		-5400000	5400000
Taxes on old machine		299000	-299000
Total	-17480000	-5699000	-11781000

	Buy New Machine	Keep Old Machine
Incremental cash flows
Operating expense	6950000		6950000
Depreciation	-4275000	-1675000	-2600000
EBT	2675000	-1675000	4350000
Taxes	615250	-385250	1000500
Net Income	2059750	-1289750	3349500
OCF	6334750	385250	5949500

Year
0	-17480000	-5699000	-11781000
1	6334750	385250	5949500
2	6334750	385250	5949500
3	6334750	385250	5949500
4	6334750	385250	5949500
NPV	3042815.49	-4450897.92	7493713.41

IRR= Where NPV of project is equal to zero

NPV of new machine (at 16%) = 245775

NPV of new machine (at 17%) = -102292

IRR = 16% + (245775 - 0)/(245775- (-102292))

= 16.71 %