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Recovery Year 1 2 3 4 5 3-Year 0.3333 0.4445 0.1481 0.0741 5-Year 0.2 0.32 0.192 0.1152 0.1152 0.0576 7-Year 0.1429 0.2449 0.1749 0.1249 0.0893 0.0893 0.0892 0.0446 6 7 8 3 PARTIAL CREDIT: SHOW ALL WORK (19 points) LFTR, Inc. is considering a replacement project that lasts for 5 years. The new equipment costs $1,500,000 and can be sold for an expected $450,000 at the end of the project. The equipment is in the 3-year class life and the depreciation factors are listed. Net operating capital is expected to increase by $325,000 and is recovered at the end of the project. The machine will save $725,000 in operating costs per year. The new equipment is replacing a machine with an estimated 5 years remaining and has a current book value of $500,000. The current salvage value is $350,000. LFTR is using the straight-line depreciation method for the old equipment and estimates the salvage value at the end of the project is zero. LFTR's tax rate is 40 percent and its cost of capital is 10 percent Calculate the NPV. Is this project acceptable using the NPV model? Why or why not? 4 Calculate the IRR. Is this project acceptable using the IRR model? Why or why not! 5 6 Calculate the payback period. Is this project acceptable using the payback period model if the payback 7 must be less than 2 years? Why or why not? 8 9 Inputs 0 Project Life 5 Years 1 New Equip $1,500,000 2 New Equip SV (Econ) t = 5 $450,000 3 Old Equip Book Value t = 0 $500,000 4 Old Equip SV (Econ) t = 0 $350,000 5 Old Equip SV (Econ) t = 5 $0 6 Increase NWC $325,000 7 Cost Savings $725,000 8 Tax 40% 9 Cost of Capital 10% 0 1 Year 0 2 3 2 Dep Factor 3 4 New Equip 5 Old Equip 6 Increase NWC 7 8 Sales Rev 9 Cost Savings 0 Dep (New) 1 Dep (Old) 2 Change in Dep 3 EBT 4 Tax 5 NI 6 OCF 7 8 SV (AT) 9 Return NWC 0 1 CF (Assets) 2 3 Decision Why? 4 NPV 5 IRR 6 Payback 7 Overall Decision 8 4 5

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