Question

PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $90 million on equipment with an assumed life of 5 years and an assumed salvage value of $30 million for tax purposes. The firm uses straight-line depreciation. The old equipment can be sold today for $90 million. A new modem pool can be installed today for $180 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 $29 million per year and decrease operating costs by $12 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 14%. Required: a. What is the net cash flow at time O 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 (i) 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 million Incremental cash flow million per year NPV million IRR

Answer 1

$90.00 $24.00 $66.001 30% $180.00 $90.00 $7.20 $97.20 A 1 Year 2 Cost of old pool 3 Depreciation on old pool for two years 4 Book Value of Old pool 5 Tax rate 6 Cost of Pool 7 Less: Salvage value of old pool 8 Add: Tax on Salvage value of old Pool 9 a) Net cash flow at time 0 10 11 Increase in Sales 12 Add: Decrease in operating costs 13 Less: Depreciation 14 Earnings before tax 15 Less: Tax@30% 16 Net Income 17 Add: Depreciation 18 b) Incremental Cash flow 19 $29.00 $12.00 $60.00 -$19.00 -$5.70 -$13.30 $60.00 $46.70 $46.70 $29.00 $12.00 $60.00 $19.00 -$5.70 -$13.301 $60.00 $46.70 $46.70 $29.00 $12.00 $60.00 -$19.00 -$5.70 -$13.30 $60.00 $46.70 $46.70 -$97.20 20 21 Discount rate 22 NPV 23 IRR 14% $11.22 20.77%

90 =(90-30)/5*2 =(B2-B3) 0.3 180 an =(B7-B4)*B5 =B6-B7+B8 1 Year 2 Cost of old pool 3 Depreciation on old pool for two years 4 Book Value of Old pool 5 Tax rate 6 Cost of Pool 7 Less: Salvage value of old pool 8 Add: Tax on Salvage value of old Pool 9 a) Net cash flow at time 0 10 11 Increase in Sales 12 Add: Decrease in operating costs 13 Less: Depreciation 14 Earnings before tax 15 Less: Tax@30% 16 Net Income 17 Add: Depreciation 18 b) Incremental Cash flow 29 12 29 12 = $B$6/3 =C11+C12-C13 =C14*30% C14-15 =C13 =C16+C17 =C18 =$B$6/3 I=D11+D12-D13 =D14*30% =D14-D15 =D13 =D16+D17 =D18 29 12 =$B$6/3 =E11+E12-E13 =E14*30% =E14-E15 =E13 =E16+E17 =E18 =-B9 21 Discount rate 22 NPV 23 IRR 0.14 =NPV(B21,C18:E18)-B9 =+IRR(B19:E19, 0.1)