You have been asked to analyze the possibility of replacing a bocce ball machine that your company bought 5 years ago. It had an expected life of 10 years at the time of purchase and cost $1,200,000 to purchase. Your firm has been depreciating the equipment using MACR 10-year depreciation Schedule. The old machine would be sold if the project is taken on. It is estimated that it could be sold for $800,000 at that time. It is expected that if the machine is not replaced, it could be sold for $100,000 at the end of its economic life.
A consultant hired by your firm (was paid a $80,000 consulting fee) has determined that the best replacement machine is made by PMBA Inc. She determined that the new machine will save somewhere between $350,000 and $450,000 a year in manufacturing costs (expected cost reduction is $400,000). The cost of the machine is $2,100,000 and has an expected life of 5 years. Even though it has a five-year life IRS guidelines allow your firm to use a 3-year MACR schedule for depreciation on the machine. The new machine will require a one-time increase in working capital of $150,000.
Your firm has a tax rate of 35%, and a required rate of return on the project of 12.00%(firm's WACC)
What is the NPV, MIRR, and IRR of the project if the expected saving are obtained? What level of saving would be the economic breakeven? Assuming that the worst case is saving of $350,000, a discount rate of 13%, how does it change the results? What if the saving was $450,000, what would the results be?