Question

Calculate the NPV, IRR, and Payback Period for the following information: A machine is purchased for $12 million with $1 million modification cost and $1 million shipping cost. Net operating working capital of $3 million is needed. The machine will generate additional annual revenue of $8 million and additional annual costs and expenses of $4 million. The machine has a 5 year life and will be depreciated using straight line depreciation. The salvage value of the machine for depreciation purposes is $3 million. It is estimated the machine can be sold after 5 years for $4 million (tax rate is 40% ). The company WACC is 8%.

Answer 1

Solution:

Calculation of NPV

Year	0	1	2	3	4	5
Additional Revenue		8,000,000.00	8,000,000.00	8,000,000.00	8,000,000.00	8,000,000.00
Additional Cost		4,000,000.00	4,000,000.00	4,000,000.00	4,000,000.00	4,000,000.00
Depreciation		2,200,000.00	2,200,000.00	2,200,000.00	2,200,000.00	2,200,000.00
Profit Before Tax		1,800,000.00	1,800,000.00	1,800,000.00	1,800,000.00	1,800,000.00
Tax		720,000.00	720,000.00	720,000.00	720,000.00	720,000.00
Profit After Tax		1,080,000.00	1,080,000.00	1,080,000.00	1,080,000.00	1,080,000.00
Cash flow after tax		3,280,000.00	3,280,000.00	3,280,000.00	3,280,000.00	3,280,000.00
Initial Investment	(14,000,000.00)
Working Capital	(3,000,000.00)					3,000,000.00
Realized Value of Machine						4,000,000.00
Total Cash Flows	(17,000,000.00)	3,280,000.00	3,280,000.00	3,280,000.00	3,280,000.00	10,280,000.00
Required Return	8%
NPV	796,454.91

Hence, the NPV of the new machine proposal is $ 796,454.91

Note 1: Calculation of Depreciation using Straight Line Method = (Total Cost - Salvage Value) / Expected life of the asset

= (12,000,000+1,000,000+1,000,000 - 3,000,000)/5

= 2,200,000

Calculation of IRR

Year	0	1	2	3	4	5
Cash Flows	(17,000,000.00)	3,280,000.00	3,280,000.00	3,280,000.00	3,280,000.00	10,280,000.00
Required Return	8%
IRR	=IRR(value,guess)
IRR	10%

The IRR of the proposal is 10%

Calculation of Payback Period

Year	0	1	2	3	4	5
Cash Flows	(17,000,000.00)	3,280,000.00	3,280,000.00	3,280,000.00	3,280,000.00	10,280,000.00
Cummulative Cashflow	(17,000,000.00)	(13,720,000.00)	(10,440,000.00)	(7,160,000.00)	(3,880,000.00)	6,400,000.00
Payback Period applying interpolation technique	= 4 years+ (3880000/10280000)
	4.38

The Payback period is 4.38 years