Problem:
A company is considering the replacement of an existing machine. Develop the relevant cash flows to analyze the proposed replacement. Determine the net present value, the IRR of the proposal and make a recommendation to accept or reject the replacement proposal. What is the highest cost of capital that the firm could have and still accept the proposal?
New Machine Cost $1.2 million
Installation Cost $150,000.00
Can be sold for $200,000.00 net of removal and clean up costs at the end of 5 years
Will be depreciated using MACRS using 5 yr recovery
Should reduce operating costs by $350,000 per year
Existing Machine ( is 2 years old)
Existing Machine ( is 2 years old) can be sold for 185000 before taxes
Cost New $800,000.00
Book Value $384,000.00
Remaining Useful Life 5 years
Depreciated under MACRS using 5 year recovery
Final 4 years of depreciation remaining
If it is held for 5 more years the machines market value will be $0.00
An increased investment in net working capital of $25,000.00 will be needed to support operations of the new machine. Firm has a 9% cost of capital and is subject to 40% tax rate.