Question

Green Glassfiber Inc. are producing wings for windmills and has a manufacturing machine that needs attention. The company is considering two options. Option A is to refurbish the current machine at a cost of € 10,000,000. If refurbished Green Glassfiber expects the machine to last another 8 years with no residual/scrap value left. Option B is to replace the machine at a cost of € 20,000,000. A new machine would last 10 years with no residual/scrap value left. Green Glassfiber expects the following net cash inflows from the two options (all in €): Year 2 Option A 5,000,000 4,000,000 3,000,000 2,000,000 1,000,000 1,000,000 1,000,000 1,000,000 Option B 7,000,000 6,000,000 5,000,000 4,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 40,000,000 6 9 10 Total 18,000,000 Green Glassfiber is using straight-line depreciation and requires an annual return on 10%. Required: 1. Compute the NPV and the IRR for the two options. 2. Which option will you recommend Green Glassfiber to use? Why? 3. Assume you recommended Green Glassfiber to buy a new machine (Option B). After 3 years the sales representative returns to Green Glassfiber telling his company a brand new machine for a price of € 24,000,000 is about to be released. This machine will raise the net cash inflow with 25% year by year and will have a lifetime of 10 years. The sales representative offer to buy the machine Green Glassfiber bought three years ago for € 20,000,000 for a price of € 5,000,000. Would you recommend Green Glassfiber to shift to this new machine after having used the old machine for 3 years? Why/why not?

Answer 1

1 2 Solution 1. O M PV factor @ 10% (b) 1.000 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 3 Option A) Year Amount (a) Cash Outflow: -1,00,00,000 Cash Inflows : 50,00,000 40,00,000 30,00,000 20,00,000 10,00,000 10,00,000 10,00,000 8 10,00,000 Net Present Value (NPV) IRR: =IRR(E4:E12,0) 24.37% (axb) € -1,00,00,000.00 € 45,45,454.55 € 33,05,785.12 € 22,53,944.40 € 13,66,026.91 € 6,20,921.32 € 5,64,473.93 € 5,13,158.12 € 4,66,507.38 € 36,36,271.73 + 20 PV factor 18 Option B) Year Amount (a) @ 10% (b) 19 Cash Outflow: -2,00,00,000 1.000 Cash Inflows : 70,00,000 0.909 60,00,000 0.826 50,00,000 0.751 40,00,000 0.683 30,00,000 0.621 30,00,000 0.564 30,00,000 0.513 30,00,000 0.467 9 30,00,000 0.424 10 30,00,000 0.386 Net Present Value (NPV) IRR: =IRR(E19:E29,0) 19.33% 600 vau Awno (axb) € -2,00,00,000.00 € 63,63,636.36 € 49,58,677.69 € 37,56,574.00 € 27,32,053.82 € 18,62,763.97 € 16,93,421.79 € 15,39,474.35 € 13,99,522.14 € 12,72,292.86 € 11,56,629.87 € 67,35,046.85

H 39 W NOO A B C D E F G 34 Solution 2. 35 As the NPV of Option B is greater than Option A, will recommend Option B 36 37 Solution 3. 38 Evaluation of offer , After 3 years PV factor Year Amount (a) @ 10% (b) (axb) 40 Cash outflow: -2,40,00,000 1.000 € -2,40,00,000.00 41 Cash Inflows: 50,00,000 1.000 € 50,00,000.00 42 50,00,000 0.909 € 45,45,454.55 43 37,50,000 0.826 € 30,99,173.55 44 37,50,000 0.751 € 28,17,430.50 45 37,50,000 0.683 € 25,61,300.46 37,50,000 0.621 € 23,28,454.96 37,50,000 0.564 € 21,16,777.24 37,50,000 0.513 € 19,24,342.94 37,50,000 0.467 € 17,49,402.68 37,50,000 0.424 € € 1590 15,90,366.07 37,50,000 0.386 € 14,45,787.34 Net Present Value (NPV) € 51,78,490.28 53 54 As the NPV is is positive, offer should be accepted 55 56 If we consider the life of new Machine 7 remaining years , NPV will be sum(G40:48) NPV = € 3,92,934.20 58 in this case also the NPV is positive, therefore it will be accepted 47 500 57 59

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