Company is replacing existing equipment with new equipment whichcan replicate what the existing machine does and also support a newproduct line.
Old equipment was purchased 3 years ago for 100,000 and wasbeing depreciated using a MACRS 5 year asset class depreciationschedule. It was expected to have a 15,000 salvage value at the endof year 5 when it was planned to be sold. The company isconsidering replacing it now with a new machine. The old machinecan be sold today for 35,000.
New machine will cost 180,000 and is expected to have aneconomic life of 8 years but is expected to use the MACRS 5 yearasset class depreciation schedule for tax purposes. It is expectedto have a salvage value of 12% of the original equipment costs atthe end of 8 years. The remaining operational years beyond thedepreciation tax schedule will not have any depreciation expensebut will continue to have operational impact.
The new machine will require an increase in working capital of10,000 in the first year of the project and will be fully recoveredat the end of the project.
The new equipment is expected to increase revenue by 40,000 peryear and reduce costs by 5,000 per year before tax impact andconsideration of depreciation impact of the new machine.
Cost of Capital is 10% and Tax Rate is 40%.
A: Base Case scenario
- Calculate the project’s NPV
- What is your recommendation?
B: Alternate Analysis Scenarios
- What if revenue impact was only 50% of projections for thefirst 4 years what would be the impact on NPV?
- What if cost reduction assumptions were not realized and nooperational costs savings were achieved? What would the impact onNPV be?
