Question

Problem 6-21 Calculating NPV and IRR for a Replacement A firm is considering an investment in a new machine with a price of $18.18 million to replace its existing machine. The current machine has a book value of $6.18 million and a market value of $4.68 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 $6.88 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 $268,000 in net working capital. The required return on the investment is 11 percent, and the tax rate is 39 percent. Assume the company uses straight-line depreciation. What is the NPV of the decision to purchase a new machine? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.) NPV $ 248124.0 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.) IRR 11.63% What is the NPV of the decision to keep the old machine? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. A negative answer should be indicated by a minus sign.) NPV What is the IRR of the decision to keep the old machine? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. A negative answer should be indicated by a minus sign.) IRR -25.38 %

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Answer 1

C3 X V f = 2*-1/4 C D E F G L M Depreciation PBT | Tax@39% Net income Depreciation EN A B Net 1 Year savings 2 0 3 1 6,880,000 4 2 6,880,000 3 6,880,000 6 4 6,880,000 4,545,000 4,545,000 4,545,000 4,545,000 2,335,000 2,335,000 2,335,000 2,335,000 7 910,650 910,650 910,650 910,650 1,424,350 1,424,350 1,424,350 1,424,350 Н. Operating Net working Incremental cash flows capital Investment cash flows $ -268,000 (18,180,000) $ (18,448,000) 5,969,350 $ - $ 5,969,350 5,969,350 $ - $ 5,969,350 5,969,350 $ - $ 5,969,350 5,969,350 $ 268,000 $ 6,237,350 IRR 11.62% Net present value 4,545,000 4,545,000 4,545,000 4,545,000 PVIF@11% Present value 1.000 $ (18,448,000.00) 0.901 $ 5,377,792.79 0.812 $ 4,844,858.37 0.731 $ 4,364,737.27 0.659 $ 4,108,735.64 5 $ 248,124.08 8 9 Operating cash flows EBIT | Tax@39% Net income Depreciation 0 Cost 10 Year savings Depreciation 11 12 1 $ - 1,545,000 13 2 $ - 1,545,000 3 $ - 1,545,000 4 $ - 1,545,000 (1,545,000)| (1,545,000) (1,545,000) (1,545,000) (602,550) (602,550) (602,550) (602,550) (942,450) (942,450) (942,450) (942,450) 1,545,000 1,545,000 1,545,000 1,545,000 602,550 602,550 602,550 602,550 Networking capital Investment Cash flow PVIF@11% Present value - (5,265,000) $ (5,265,000) 1.000 $ (5,265,000.00) $ 602,550 0.901 $ 542,837.84 $ 602,550 0.812 $ 489,043.10 $ 602,550 0.731 $ 440,579.37 $ 602,550 0.659 $ 396,918.35 IRR -25.29% Net present value $ (3,395,621.35) 17 20 21 19 WDV of machine at the time of sale $ 6,180,000 Sale value of machine $ 4,680,000 Profit/(Loss) on sale $ -1,500,000 22 Tax@39% $ -585,000 23 After tax cash flows from sale of asset $ 5,265,000 24 25 New machine NPV $ 248,124.08 26 New machine IRR 11.62% 27 Old machine NPV -$3,395,621.35 28 Old machine IRR -25.29%

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