Question

·         From Scenario 2, what are your recommendations on the investment project? Explain your reasoning.

·         From Scenario 2, what are your recommendations for investment in the new technology?

1.

	Years to maturity	15
	Face value	$              1,000
a)	Yield to maturity	8%
b)	Yield to maturity	10%
c)	Yield to maturity	12%
	Output area:
a)	Price	$315.24
b)	Price	$           239.39
c)	Price	$           182.70

2.

	Settlement date	1/1/2000
	Maturity date	1/1/2015
	Annual coupon rate	7.00%
	Coupons per year	2
a)	Yield to maturity	8%
b)	Yield to maturity	10%
c)	Yield to maturity	12%
	Output area:
a)	Price	$    813.35
b)	Price	$    672.52
c)	Price	$    565.05

3.

	Dividend one	$            12.00
	Dividend two	5.00
	Dividend three	7.00
	Dividend four	3.00
	Dividend growth rate	4%
	Required return	15%
	Output area:
	Year 4 price	$            28.36
	Share price	$            36.75

4.

	Annual cash inflows:
	Year 1	$          6,000
	Year 2	5,500
	Year 3	7,000
	Year 4	8,000
	Discount rate	14%
	Initial cost	$        15,000
		.
	Output area:
	Discounted payments:
	Year 1	$            3.16
	Year 2	$            2.53
	Year 3	$            3.38
	Year 4
	Payback period	9.07

5.

	Cost of new machine	$        16,000,000
	Old machine book value	$          5,000,000
	Old machine market value	$          5,000,000
	Years of operation	5
	Saved operating costs	$          5,700,000
	Net working capital	$             300,000
	Required return	12%
	Tax rate	39%
	*Depreciation straight-line
	Output area:
		Buy new machine		Keep old machine		Incremental analysis
	Initial cash outlay:
	Purchase new machine	$        16,000,000				$       16,000,000
	Net working capital	300,000				300,000
	Sell (buy) old machine	5000000				5000000
	Taxes on old machine	10000000				10000000
	Total	$        11,300,000				$       11,300,000
	Incremental cash flows
	Operating expense	$          5,700,000		0		$         5,700,000
	Depreciation	(3,200,000)		$        (1,666,667)		($1,533,333)
	EBT	$          2,500,000		$        (1,666,667)		$         4,166,667
	Taxes	(975,000)		(650,000)		(1,625,000)
	Net income	$          1,525,000		$        (1,016,667)		$         2,541,667
	OCF	$          4,725,000		$            (650,000)		$         4,075,000
	Year	Cash flow		Cash flow		Cash flow
	0	$      (11,300,000)				$     (11,300,000)
	1	4,725,000		(650,000)		4,075,000
	2	4,725,000		(650,000)		4,075,000
	3	4,725,000		(650,000)		4,075,000
	4	5,025,000				5,025,000
	NPV	$        902,796.00		$   (2,656,895.00)		$   3,559,691.00
	IRR	14.20%		-12.83%		23.96

Answer 1

Basis the analysis given in the question as we can see the NPV of buying new machine is positive and much more than NPV of keeping the old machine which is negetive. The decsision should be to buy the new machine, the incremental analysis also shows the same as it is also positive.

If we see the IRR, for buying the new machine option the IRR is positive and is 14.2% which is more than required return of 12% where as IRR of keeping the old machine is negetive hence IRR method also says that new machine should be bought.