Question

8. Replacement analysis Aa Aa Purple Whale Inc. is a company that produces iBooks, among several other products. Suppose that Purple Whale Inc. considers replacing its old machine used to make iBooks with a more efficient one, which would cost $2,000 and require $280 annually in operating costs except depreciation. After-tax salvage value of the old machine is $400, while its annual operating costs except depreciation are $1,200. Assume that, regardless of the age of the equipment, Purple Whale Inc.'s sales revenues are fixed at $2,500 and depreciation on the old machine is $400. Assume also that the tax rate is 40% and the project's risk-adjusted cost of capital, r, is the same as weighted average cost of capital (WACC) and equals 10% and they are constant over four years. Based on the data, net cash flows (NCFS) before replacement are

Answer 1

		CASH FLOWS BEFORE REPLACEMENT
	a	Annual Sales Revenue	$2,500
	b	Annual Operating Cost except   Depreciation	($1,200)
	c	Depreciation expense	($400)
	d=a+b+c	Before tax operating income	$900
	e=d*40%	Tax expense	-$360
	f=d+e	Net Operating Profit after tax(NOPAT)	$540
	g	Add: Depreciation (non cash expense)	$400
	h=f+g	Annual Operating Cash Flow	$940
		NCF before replacement	$940