Question

A small factory is considering replacing its existing coining press with a newer, more efficient one. The existing press was purchased five years ago at a cost of $200,000, and it is being depreciated according to a 7-year MACRs depreciation schedule and the first five years of depreciation have been taken (see below for MACRs chart). The CFO estimates that the existing press has 6 years of useful life remaining. The purchase price for the new press is $306,000. The installation of the new press would cost an additional $24,000, and this cost would be capitalized and added to the depreciable base rather than expensed immediately. The new press (if purchased) would be depreciated using the 7-year MACRs depreciation schedule. Interest expense associated with the purchase of the new press is estimated to be roughly $7,900 per year for the next 6 years. The appeal of the new press is that it is estimated to produce a pre-tax operating cost savings of $75,000 per year for the next 6 years, and the new press also has a useful life of 6 years. Also, if the new press is purchased, the old press can be sold for $30,000 today. The CFO believes that the new press would be sold for $45,000 at the end of its 6-year useful life. Assume that NWC would not be affected. The company has an average tax rate of 25% and a marginal tax rate of 30% going forward. The cost of capital (i.e., discount rate) for this project is 12%. Develop the incremental cash flows for this replacement decision and use them to calculate NPV and IRR. Next, make a reccomendation about whether or not the existing coining press should be replaced at this time. Make sure that it is easy to determine how you arrived at your incremental cash flows!

Answer 1

Answer:

The detailed answer and the related working of this question is provided below:

4.46% А B с Τ Ε F G H K M N 0 Р 1 Input values MACRS Depreciation rates 7 year asset: 2 Purchase price of old machine 2,00,000.00 Savings in cost 75,000.00 14.29% 24.49% 17.49% 12.49% 8.93% % 8.92% 8.93% 3 Useful life of old machine 11 Increase in cost 0.00 4 Remaining life 6 Cost of capital 12.00% 5 Accumulated Dep on old machine 1,12,540.00 Tax rate 25% 6 Salvage value of old machine 0.00 7 Today's selling price of old machir 24,000.00 8 Purchase price of new machine 3,06,000.00 9 Useful life of new machine 6 10 Salvage value of new machine 30,000.00 11 12 Solution: 13 $ 0 1 2 3 4 5 6 14 Purchase price of new machine 3,06,000.00 (A) Incremental cash flows -2,66,135.00 75,000.00 75,000.00 75,000.00 75,000.00 75,000.00 75,000.00 15 Less: Sale price of old machine -24,000.00 Depreciation of old Machine 0.00 24,980.00 17,860.00 17,840.00 17,860.00 8,920.00 0.00 16 Less: Tax savings on loss on sale -15,865.00 Depreciation of new machine 0.00 43,727.40 74,939.40 53,519.40 38,219.40 27,325.80 27,295.20 17 Incremental cash outflow 2,66,135.00 (B) Incremental Depreciation 0.00 18,747.40 57,079.40 35,679.40 20,359.40 18,405.80 27,295.20 18 Operating Profit (A-B) -2,66,135.00 56,252.60 17,920.60 39,320.60 54,640.60 56,594.20 47,704.80 19 Tax/(Tax Savings) @ 29% 0.00 14,063.15 4,480.15 9,830.15 13,660.15 14,148.55 11,926.20 20 After tax profit -2,66,135.00 42,189.45 13,440.45 29,490.45 40,980.45 42,445.65 35,778.60 21 Add: Incremental Depreciation 0.00 18,747.40 57,079.40 35,679.40 20,359.40 18,405.80 27,295.20 22 Cash flow after depreciation -2,66,135.00 60,936.85 70,519.85 65,169.85 61,339.85 60,851.45 63,073.80 23 Add: Incremental Salvage value 0.00 0.00 0.00 0.00 0.00 0.00 30,000.00 24 Total Cash flows -2,66,135.00 60,936.85 70,519.85 65,169.85 61,339.85 60,851.45 93,073.80 25 26 NPV $10,306.18 27 IRR 13.46% 28 Decision: The project should be selected since sine it has positive NPV and IRR > cost of capital

G Ι Η Н. к P M N O MACRS Depreciation rates 7 year asset: 0.1749 0.1249 0.0893 0.0892 0.2449 0.0893 0.0446 75000 0.1429 0 0.12 0.25 A IC D E F 1 Input values 2 Purchase price of old machine 200000 Savings in cost 3 Useful life of old machine 11 Increase in cost 4 Remaining life 6 6 Cost of capital 5 5 Accumulated Dep on old machine =D2'SUMJ2:L2) Tax rate 6 Salvage value of old machine 0 7 Today's selling price of old machine 24000 8 Purchase price of new machine 306000 9 Useful life of new machine 6 10 Salvage value of new machine 30000 11 12 Solution: 13 $ 14 Purchase price of new machine =D8 15 Less: Sale price of old machine =-D7 16 Less: Tax savings on loss on sale = (D7-02-05))"H5 17 Incremental cash outfloy ESUMID14:016) 18 19 20 21 22 23 24 25 26 27 28 Decision: The project should be selec (A) Incremental cash flows Depreciation of old Machine Depreciation of new machine (B) Incremental Depreciation Operating Profit (A-B) Tax/(Tax Savings) @ 29% After tax profit Add: Incremental Depreciation Cash flow after depreciation Add: Incremental Salvage value Total Cash flows 0 =-117 0 0 =J16-J15 = J14-J17 0 =J18-J19 =J17 = J21+J20 0 =J22+J23 1 2 3 4 5 6 = $H$2-$H$3 = $H$2-$H$3 = $H$2-$H$3 = $H$2-$H$3 = $H$2-$H$3 = $H$2-$H$3 = $D$2 M2 = $D$2'N2 = $D$2'02 = $D$2'P2 = $D$2'Q2 = $D$2'R2 = $D$8'J2 = $D$8'K2 = $D$8'L2 = $D$8 M2 = $D$8N2 = $D$8'02 =K16-K15 =L16-L15 =M16-M15 =N16-N15 =016-015 =P16-P15 =K14-K17 =L14-L17 =M14-M17 =N14-N17 =O14-017 =P14-P17 =K18 $H$5 =L18' $H$5 =M18' $H$5 =N18'$H$ 5018$H$5 =P18' $H$5 ' =K18-K19 =L18-L 19 EM18-M19 -N18-N19 =O18-019 =P18-P19 =K17 =L17 =M17 =N17 =O17 =P17 =K21+K20 =L21+L20 =M21+M20 =N21+N20 =O21+020 =P21+P20 0 0 0 0 0 =D10-06 =K22+K23 =L22+L23 =M22+M23 =N22+N23 =O22+023 =P22+P23 NPV IRR =NPV(H4.J24:P24) = IRR(J24:P24)