Question

17. Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: Machine 190-3, which has a cost of $220,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $97,000 per year; and Machine 360-6, which has a cost of $320,000, a 6-year life, and after-tax cash flows of $93,400 per year. Knitting machine prices are not expected to rise because inflation will be offset by cheaper components (microprocessors) used in the machines. Assume that Filkins's cost of capital is 12%.

Calculate the two projects' extended NPVs. Do not round intermediate calculations. Round your answers to the nearest dollar.

Machine 190-3: $__

Machine 360-6: $__  

Should the firm replace its old knitting machine? If so, which new machine should it use?

The firm (Select one)

1. should replace its old knitting machine with Machine 190-3
2. should replace its old knitting machine with Machine 360-6
3. should not replace its old knitting machine

By how much would the value of the company increase if it accepted the better machine? Do not round intermediate calculations. Round your answer to the nearest dollar.

$__  

What is the equivalent annual annuity for each machine? Do not round intermediate calculations. Round your answers to the nearest dollar.

Machine 190-3: $ __

Machine 360-6: $ __

18. The Aubey Coffee Company is evaluating the within-plant distribution system for its new roasting, grinding, and packing plant. The two alternatives are (1) a conveyor system with a high initial cost but low annual operating costs and (2) several forklift trucks, which cost less but have considerably higher operating costs. The decision to construct the plant has already been made, and the choice here will have no effect on the overall revenues of the project. The cost of capital for the plant is 13%, and the projects' expected net costs are listed in the following table:

	Expected Net Cost
Year	Conveyor		Forklift
0	-$500,000		-$200,000
1	-120,000		-160,000
2	-120,000		-160,000
3	-120,000		-160,000
4	-120,000		-160,000
5	-20,000		-160,000

1. What is the IRR of each alternative?

The IRR of alternative 1 is (Select one from below) undefined   11%      13%                            15%            

The IRR of alternative 2 is (Select one from options below)

undefined             11%                            13%                            15%            

2. What is the present value of costs of each alternative? Do not round intermediate calculations. Round your answers to the nearest dollar. Use a minus sign to enter negative values, if any.

Alternative 1: $__

Alternative 2: $__  

Which method should be chosen? (select one)

IRR method       or        PV method         

Answer 1

17 MACHINE 190-3:

Calculate present value of cash inflows : We are given that the after tax cash flows of 97,000 are constant every year, that is, it is in the form of annuity. Therefore in order to find the present value of cash inflows, we multiply the cash flows by present value annuity factor (PVIFA) at 12% for 3 years.

Present value of cash inflows = 97,000 * PVIFA12%,3years

= 97,000 * 2.40   

= $232800

STEP 2: Calculate NPV

NPV = Present value of cash inflows - Initial investment

= 232800 - 220,000 = $12,800

MACHINE 360-6

NPV = (93400 * PVIFA12%,6years) - 320,000

= (93400 * 4.11) - 320,000

= 383874 - 320,000

= $63784

Machine 360-6 would be accepted, since it has a higher NPV

If this machine is accepted, the value will increase by 63784 - 12800  = $50,984

Answer c

The equivalent annual net present value is determined by dividing the NPV of cash flows of the project by the annuity factor corresponding to the life of the project at the given cost of capital.

• Equivalent annual annuity for machine 190-3 = 12800 / 2.4 = $5,333.33
• Equivalent annual annuity for machine 360-6 = 63784 / 4.11 = $15,519.22

18

IRR is defined at the rate at which NPV of the project is zero.The IRR can be calulated as follows

year	conveyor	forklift
0	- 500000	-200000
1	120000	160000
2	120000	160000
3	120000	160000
4	120000	160000
5	20000	160000
	0 %	75%

The IRR of conveyor is 0 % and of forklift is 75% . Hence thev IRR is undefined for both conveyor and forklift.

NPV of Conveyor = (-120000 * PVIFA13%,4years + -20000*PVF 13%,5) - 500000 = -$867260

NPV of forklift   = (-160000* PVIFA13%,5years) - 200000 = - $762757

NPV method must be chosen .