Question

PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $75 million on equipment with an assumed life of 5 years and an assumed salvage value of $25 million for tax purposes. The firm uses straight-line depreciation. The old equipment can be sold today for $120 million. A new modem pool can be installed today for $240 million. This will have a 3-year life and will be depreciated to zero using straight-line depreciation. The new equipment will enable the firm to increase sales by $39 million per year and decrease operating costs by $19 million per year. At the end of 3 years, the new equipment will be worthless. Assume the firm's tax rate is 30% and the discount rate for projects of this sort is 13%. Required: a. What is the net cash flow at time 0 if the old equipment is replaced? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.) b. What are the incremental cash flows in years (0) 1; (ii) 2; (iii) 3? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.) c. What is the NPV of the replacement project? (Do not round intermediate calculations. Enter the NPV in millions rounded to 2 decimal places.) d. What is the IRR of the replacement project? (Do not round intermediate calculations. Enter the IRR as a percent rounded to 2 decimal places.) Net cash flow Incremental cash flow NPV IRR million million per year million

Answer 1

a)	Net Cash Flow At 0 if old equipment replaced
	Sale value of old equipment	$          120	Million
	Less: Book value of old
	($75-(75-25/5*2)	55
	Gain On sale	$            65
	Tax On Gain	$      19.50
	Net cash flow after tax	$    100.50
	Less:
	Cost of new equipment	$          240	Million
	Net Cash Flow	$ -139.50	Million
b)	Incremental cash flow per year
1	Incremental revenue	$      39.00
	Add:
2	Decrease in operating cost	$      19.00
	Less:
3	Annual Depreciation	$      80.00
	[(240/3)
4	Income for tax purpose	$     -22.00
5	Tax Savings at 30%	$         6.60
6	Incremental cash flow (1+2+5)	$      64.60
c)
Net Present Value
	Calculation Of NPV
a	Investment	139.5
b	annual cash inflow	64.6
c	PV annuity factor for 3 years and 13 %	2.3611526
d	PV of Annual Cash Inflow (b*c)	152.53046
e	Salvage Value	0
f	PV factor of year 3	0.6930502
g	PV Of Salvage Value	0
h	Net Present Value (d+g-a))	13.03
d)	IRR = 18.43%