Problem
Comprehensive capital budgeting
The Flemingo Inc. purchased a special machine 1 year ago at a cost of $12,000. At the time of purchase the machine was estimated to have a useful life of 6 years and no salvage value. The annual cash operating cost is approximately $20,000. A new machine has just come on the market which will do the same job but with an annual cash operating cost of only $17,000. This new machine costs $21,000 and has an estimated life of 5 years with zero salvage value. The old machine can be sold for $10,000 to a scrap dealer. Straight line depreciation is used, and the company's income tax rate is 40 percent.
Assuming a cost of capital of 8 percent after taxes, calculate
1. Loss or gain on sale of old machine
2. The initial investment
3. The incremental cash inflow after tax
4. The NPV of the new investment, and
5. The IRR on the new investment
6. What decision can be made from your answer in (3) and (4) above