Question

A firm is considering an investment in a new machine with a price of $15.7 million to replace its existing machine. The current machine has a book value of $5.5 million and a market value of $4.2 million. The new machine is expected to have a 4-year life, and the old machine has four years left in which it can be used. If the firm replaces the old machine with the new machine, it expects to save $6.35 million in operating costs each year over the next four years. Both machines will have no salvage value in four years. If the firm purchases the new machine, it will also need an investment of $260,000 in net working capital. The required return on the investment is 9 percent and the tax rate is 21 percent. The company uses straight-line depreciation. What is the NPV of the decision to purchase a new machine? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to 2 decimal places, e.g., 1,234,567.89.) What is the IRR of the decision to purchase a new machine? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) What is the NPV of the decision to purchase the old machine? (A negative amount should be indicated by a minus sign. Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to 2 decimal places, e.g., 1,234,567.89.) What is the IRR of the decision to purchase the old machine? (A negative amount should be indicated by a minus sign. Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. )

Answer 1

Solution for NPV and IRR when New Machine is purchased and replaced by Old Machine:-

Cash flows, NPV and IRR Calculations when Purchasing New Machine
Time	Cash Flow	Description	Discount Factor @ 9%	Present Value of Cash Flows
0	-15700000	Investment in New Machine	1.000	-15700000.00
0	4200000	Inflow due to sale of old machine	1.000	4200000.00
0	-260000	Cash outflow for Net Working Capital	1.000	-260000.00
1	5840750	Net Cash Inflow after adjusting for Tax and Depreciation	0.917	5358486.24
2	5840750	Net Cash Inflow after adjusting for Tax and Depreciation	0.842	4916042.42
3	5840750	Net Cash Inflow after adjusting for Tax and Depreciation	0.772	4510130.66
4	5840750	Net Cash Inflow after adjusting for Tax and Depreciation	0.708	4137734.55
			NPV of the Project	7162393.87	Sum of all Present Value of Cash Flows
Income Statement for New Machine						Time	Cash Flows
Savings on Operating Cost	6350000		IRR of the Project	34.48%		0	-11760000.00
Depreciation Less	-3925000					1	5840750
Income before Tax	2425000					2	5840750
Tax @ 21%	-509250					3	5840750
Income after Tax	1915750					4	5840750
Add Depreciation	3925000
Cash Flow	5840750

Solution for Old Machine being used instead of New Machine its NPV and IRR:-

Cash flows, NPV and IRR Calculations when Purchasing New Machine
Time	Cash Flow	Description	Discount Factor @ 9%	Present Value of Cash Flows
1	-4727750	Cash Flow after adjusting for Taxes and Depreciation	0.917	-4337385.32
2	-4727750	Cash Flow after adjusting for Taxes and Depreciation	0.842	-3979252.59
3	-4727750	Cash Flow after adjusting for Taxes and Depreciation	0.772	-3650690.45
4	-4727750	Cash Flow after adjusting for Taxes and Depreciation	0.708	-3349257.29
			NPV of the Project	-15316585.65
Income Statement for Old Machine
Excess Expense on Operating Cost	-6350000		IRR of the Project	Cannot Calculate as No Net Inflows all year Outflows only
Depreciation Less	-1375000
Income before Tax	-7725000
Tax @ 21%	1622250
Income after Tax	-6102750
Add Depreciation	1375000
Cash Flow	-4727750