9) Global company is considering replacing one of its equipment with a more efficient one. The...

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9) Global company is considering replacing one of its equipmentwith a more efficient one. The old machine has a book value of$60,000 and a remaining useful life of 5 years. It can sell the oldmachine now for $ 265,000. The old machine is being depreciated by120,000 per year straight line. The new machine has a purchaseprice of $ 1,175,000 an estimated useful life and 5 years MACRSclass life and salvage value of $145,000. Annual economic savingsis $255,000 if new machine is installed. Taxes 40% and WACC is12%.
a. Calculate the initial cash flow at time 0, which istoday.
b. Calculate the cash flows for years 1 thru 5.
c. Calculate the terminal value at year 5
d. Calculate the NPV and IRR of the project and make a decisionon whether the company should accept or reject the investment andwhy?

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3.8 Ratings (727 Votes)



a)	After tax value of old machine			=	265000-(265000-60000)*40%
				=	183000

	Cash outflow today			=	1,175,000-183,000
				=	992000

b)	Calculation of Depreciation

		Year		1	2	3	4	5	6 (WDV )
		Rate		20%	32%	19.20%	11.52%	11.52%	5.72%
		Cost		1,175,000	1,175,000	1,175,000	1,175,000	1,175,000	1,175,000
		Dep		235000	376000	225600	135360	135360	67210

	Calculation of cash flow
		Year	1	2	3	4	5	total
		saving	255000	255000	255000	255000	255000
		dep	235000	376000	225600	135360	135360
		profit before tax	20000	-121000	29400	119640	119640
		tax	8000	-48400	11760	47856	47856
		profit after tax	12000	-72600	17640	71784	71784
		Cash flow	247000	303400	243240	207144	207144
		PVF @ 12%	0.8929	0.7972	0.7118	0.6355	0.5674
		Discounted CF	220535.7	241868.6	173133.4	131643.8	117539.1	884720.6


c)
	WDV at year 5 (dep for year 6)			=	67210


	After tax salvage value of machine after 5 years				=	145000-(145000-67210)*40%
						113884

	PV of salvage value today				=	113884*0.5674
					=	64617.78

d)	NPV		=	Dicounted CF+PV of terminal CF-cash outflow At year 0
			=	884720.6+64617.78-992000
			=	-42661.62

	IRR		=	10.2673%

	Company should reject the project as NPV is negative or IRR is less than WACC

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9) Global company is considering replacing one of its equipmentwith a more efficient one. The old machine has a book value of$60,000 and a remaining useful life of 5 years. It can sell the oldmachine now for $ 265,000. The old machine is being depreciated by120,000 per year straight line. The new machine has a purchaseprice of $ 1,175,000 an estimated useful life and 5 years MACRSclass life and salvage value of $145,000. Annual economic savingsis $255,000 if new machine is installed. Taxes 40% and WACC is12%.a. Calculate the initial cash flow at time 0, which istoday.b. Calculate the cash flows for years 1 thru 5.c. Calculate the terminal value at year 5d. Calculate the NPV and IRR of the project and make a decisionon whether the company should accept or reject the investment andwhy?