Question

Tomato plant Inc. wants to replace its current machinery which is listed in its balance sheet with a book value of $5 million, with new machinery costing $16 million. The current machinery can be sold for $3 million. The new machinery has an expected life of four years. The current machinery can still be used for another four years. Both machinery will have no salvage value at the end of their useful lives. The replacement of the current with the new machinery is expected to result in $6 million saving in operating costs each year for the next four years. If the firm purchases the new machinery, it will also need an immediate investment of $300,000 in net working capital. The required return on the investment is 10 percent, and the tax rate is 39 percent. What are the NPV and IRR of the decision to replace the old machinery? Should Tomato plant replace the old machinery?

Answer 1