Question

A firm is considering an investment in a new machine with a price of $18.12 million to replace its existing machine. The current machine has a book value of $6.12 million and a market value of $4.62 million. The new machine is expected to have a four-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 $6.82 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 $262,000 in net working capital. The required return on the investment is 11 percent, and the tax rate is 35 percent. Assume the company uses straight-line depreciation.

1. What is the NPV of the decision to purchase a new machine?

2. ​What is the IRR of the decision to purchase a new machine?

3. What is the NPV of the decision to keep the old machine?

4. What is the IRR of the decision to keep the old machine?

Answer 1

Operating Net working Tax@35% | Net income Depreciation | cash flows | capital | Investment | cash flows PVIF@11% Incremental 1YearNet savings Depreciation PBT Present value 0 16,820,000 4,530,000 2,290,000 2 6,820,000 36,820,0004,530,0002,290,000 801,5001,488,500 4,530,000 6,018,500 $ 801,5001,488,500 801,5001,488,500 4,530,0006,018,500 $ 801,5001,488,500 4,530,000 6,018,500262,000 $262,000 (18,120,000 (18,382,000) S 6,018,500 S 6,018,500 6,018,500 S 6,280,500 12.17% 1.000 0.901 S 0.812 S 0.731 0.659 S (18,382,000.00) 5,422,072.07 4,884,749.61 4,400,675.33 4,137,159.88 4,530,000 2.290,000 4530,0006,018,500 S 4,530,000 2,290,000 IRR Net present value S462.656.90 Cost Operating Net working Tax@35% | Net income Depreciation | cash flows | capital | Investment | Cash flow PVIF@11% 10 Yearsavings Depreciation EBIT Present value 5,145,000)(5,145,000) S 535,500 535,500 S535,500 S 535,500 -27 .72% 1.000 0.901 S 0.812 S 0.731 0.659 S 5,145,000.00) 482,432.43 434,623.81 391,552.98 352,750.44 0 1,530,000 1,530,000)(535,500) (994,500)1,530,000 1,530,000 (1,530,000)(535,500(994,500)1,530,000 ,530,0001,530,000)(535,500)(994,500)1,530,000 1,530,000 (1,530,000)(535,500)(994,500)1,530,000 535,500 535,500 535,500 535,500 13 15 16 17 IRR Net present value -$3,483,640.33 18 WDV of machine at the time of sale Sale value of machine Profit//Loss) on sale Tax@ 35% After tax cash flows from sale of asset 5,145,000 S6,120,000 4,620,000 $-1,500,000 $ -525,000 20 23

New machine:
NPV	$       462,656.90
IRR	12.17%
Old machine:
NPV	-$3,483,640.33
IRR	-27.72%