Question

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 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 $250,000 in net working capital. The required return on the investment is 10 percent, and the tax rate is 21 percent. What are the NPV and IRR of the decision to replace the old machine?

Answer 1

Tax rate	21.00%
	Old equipment
WDV	$           5,400,000
Sale price	$           4,100,000
Gain/(Loss), (4100000-5400000)	$          (1,300,000)
Tax benefit	$             (273,000)	=-1300000*21%
Sale price after tax	$           4,373,000	=4100000--273000
Cost of new equipment	$         15,600,000
Less sale proceed of old equipment	$          (4,373,000)
Net investment	$         11,227,000
Depreciation on new equipment
Year	Cost	Dep rate	Depreciation	Depreciation
1	$         15,600,000	25.00%	=15600000*25%	$           3,900,000
2	$         15,600,000	25.00%	=15600000*25%	$           3,900,000
3	$         15,600,000	25.00%	=15600000*25%	$           3,900,000
4	$         15,600,000	25.00%	=15600000*25%	$           3,900,000
Depreciation on old equipment
Year	WDV	Dep rate	Depreciation	Depreciation
1	$           5,400,000	25.00%	=5400000*25%	$           1,350,000
2	$           5,400,000	25.00%	=5400000*25%	$           1,350,000
3	$           5,400,000	25.00%	=5400000*25%	$           1,350,000
4	$           5,400,000	25.00%	=5400000*25%	$           1,350,000
Incremental depreciation
Year	New Depreciation	Old Depreciation	Additional depreciation
1	$           3,900,000	$        1,350,000	$                 2,550,000
2	$           3,900,000	$        1,350,000	$                 2,550,000
3	$           3,900,000	$        1,350,000	$                 2,550,000
4	$           3,900,000	$        1,350,000	$                 2,550,000
After tax value of operating profits
Year			Cost saving	Dep rate	After tax saving
1			$                 6,300,000	=6300000*(1-21%)	$    4,977,000
2			$                 6,300,000	=6300000*(1-21%)	$    4,977,000
3			$                 6,300,000	=6300000*(1-21%)	$    4,977,000
4			$                 6,300,000	=6300000*(1-21%)	$    4,977,000
				Total	$ 19,908,000
Tax shield
Year	Aditional depreciation	Tax shield	Tax shield
1	$           2,550,000	=2550000*21%	$                    535,500
2	$           2,550,000	=2550000*21%	$                    535,500
3	$           2,550,000	=2550000*21%	$                    535,500
4	$           2,550,000	=2550000*21%	$                    535,500
		Total	$                 2,142,000
Calculation of NPV						10%
Year	Capital commitment	Working capital	Annual benefit	Dep tax shield	Annual free cashflow	PV factor, 1/(1+r)^time	Total * PV factor
0	$        (11,227,000)	$       &n 0 0 Add a comment Know the answer? Your Answer: Post as a guest Your Name: What's your source? Earn Coins Coins can be redeemed for fabulous gifts. Log In Sign Up Post as anonymous Post Your Answer 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 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 $18.03 million... 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