Question

PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $115 million on equipment with an assumed life of 5 years and an assumed salvage value of $15 million for tax purposes. The firm uses straight-line depreciation. The old equipment can be sold today for $80 million. A new modem pool can be installed today for $150 million. This will have a 3-year life and will be depreciated to zero using straight-line depreciation. The new equipment will enable the firm to increase sales by $25 million per year and decrease operating costs by $10 million per year. At the end of 3 years, the new equipment will be worthless. Assume the firm’s tax rate is 30% and the discount rate for projects of this sort is 10%.

Required:

a. What is the net cash flow at time 0 if the old equipment is replaced? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

b. What are the incremental cash flows in years: (i) 1; (ii) 2; (iii) 3? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

c. What is the NPV of the replacement project? (Do not round intermediate calculations. Enter the NPV in millions rounded to 2 decimal places. )

d. What is the IRR of the replacement project? (Do not round intermediate calculations. Enter the IRR as a percent rounded to 2 decimal places.)

Answer 1

a)

depreciation = (asset value- salavage) / usefull life

depreciation of old machine =(115-15)/5 =$20 M per year

book at end of second year = 115- 20*2 = 75

gain on sale = sale value - book value

=80-75 = $5 M

net cash flow = 80 - 5* 30% = $ 78.5 m

b)

new investment vlaue = 150 -78.5 =71.5 M

c) npv

d)IRR