Question

A firm is considering an investment into a new machine with a price of $18 million...

A firm is considering an investment into a new machine with a price of $18 million to replace its existing machine. The current machine has a book value of $6 million and a market value of $4.5 million. The new machine is expected to have a four-year life, and also 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 $6.5 million in cash operating costs each year over the next four years. Both machines will have no book value (e.g. they are fully depreciated) and no salvage value in four years (you may assume linear depreciation). If the firm purchases the new machine, it will also need an additional investment of $600,000 in net working capital during the project lifetime. The required return on the investment is 10 percent, and the tax rate is 40 percent. Should the company replace the old machine based on NPV?

Homework Answers

Answer #1
Time line 0 1 2 3 4
Proceeds from sale of existing asset =selling price* ( 1 -tax rate) 2700000
Tax shield on existing asset book value =Book value * tax rate 2400000
Cost of new machine 18000000
Initial working capital -600000
=Initial Investment outlay 22500000
100.00%
Savings 6500000 6500000 6500000 6500000
-Depreciation Cost of equipment/no. of years 4500000 4500000 4500000 4500000 0 =Salvage Value
=Pretax cash flows 11000000 11000000 11000000 11000000
-taxes =(Pretax cash flows)*(1-tax) 6600000 6600000 6600000 6600000
+Depreciation -4500000 -4500000 -4500000 -4500000
=after tax operating cash flow 2100000 2100000 2100000 2100000
reversal of working capital 600000
+Tax shield on salvage book value =Salvage value * tax rate 0
=Terminal year after tax cash flows 600000
Total Cash flow for the period 22500000 2100000 2100000 2100000 2700000
Discount factor= (1+discount rate)^corresponding period 1 1.1 1.21 1.331 1.4641
Discounted CF= Cashflow/discount factor 22500000 1909090.909 1735537.19 1577761.082 1844136.3
NPV= Sum of discounted CF= 29566525.51

Replace as NPV is positive

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
A firm is considering an investment in a new machine with a price of $15.6 million...
A firm is considering an investment in a new machine with a price of $15.6 million to replace its existing machine. The current machine has a book value of $5.4 million and a market value of $4.1 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 $6.3 million in...
A firm is considering an investment in a new machine with a price of $18.03 million...
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...
A firm is considering an investment in a new machine with a price of $18.1 million...
A firm is considering an investment in a new machine with a price of $18.1 million to replace its existing machine. The current machine has a book value of $6.1 million and a market value of $4.6 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 $6.8 million in...
A firm is considering an investment in a new machine with a price of $18.05 million...
A firm is considering an investment in a new machine with a price of $18.05 million to replace its existing machine. The current machine has a book value of $6.05 million and a market value of $4.55 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 $6.75 million in...
A firm is considering an investment in a new machine with a price of $15.6 million...
A firm is considering an investment in a new machine with a price of $15.6 million to replace its existing machine. The new machine is expected to have a four-year life. If the firm replaces the old machine with the new machine, it expects to save $6.3 million in operating costs each year over the next four years. The new machine will have no salvage value in four years. If the firm purchases the new machine, it will also need...
A firm is considering an investment in a new machine with a price of $16.1 million...
A firm is considering an investment in a new machine with a price of $16.1 million to replace its existing machine. The current machine has a book value of $5.8 million and a market value of $4.5 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 $6.5 million in...
Green Zebra wants to test out alternative energy for its facilities. It is considering an investment...
Green Zebra wants to test out alternative energy for its facilities. It is considering an investment in a new wind-energy tower with a price of $7million to replace its existing natural gas furnace. Today, the current machine has a book value of $4million and could be sold for $3.5 million. The new machine is expected to have three year life, and the old machine has three years remaining in its economic life. Both machines use straight line depreciation to a...
Green Zebra wants to test out alternative energy for its facilities. It is considering an investment...
Green Zebra wants to test out alternative energy for its facilities. It is considering an investment in a new wind-energy tower with a price of $7million to replace its existing natural gas furnace. Today, the current machine has a book value of $4million and could be sold for $3.5 million. The new machine is expected to have three year life, and the old machine has three years remaining in its economic life. Both machines use straight line depreciation to a...
Veridian Dynamics is considering the purchase of a new cloning machine, which will cost $390 million...
Veridian Dynamics is considering the purchase of a new cloning machine, which will cost $390 million plus an additional $10 million to ship and install. The new machine will replace the existing machine, which has zero book value and could be sold today for $40 million. The new machine will have a 4 year useful life and will be depreciated to zero using the straight line method. The machine will require $10 million worth of spare parts to be pruchased...
The ABD company is considering the purchase of a new machine to replace an out of...
The ABD company is considering the purchase of a new machine to replace an out of date machine that has a book value of $18000 and can be sold today for $2,000. The old machine is being depreciated on a straightline basis over 4 more years to a book value of $2000 at the end of the fourth year. The old machine generates annual revenues of $105000 and annual expenses of $75000. This machine requires a fixed investment of $5000...
ADVERTISEMENT
Need Online Homework Help?

Get Answers For Free
Most questions answered within 1 hours.

Ask a Question
ADVERTISEMENT