Question: Loma Inc has an opportunity to purchase a new more

Loma, Inc. has an opportunity to purchase a new, more efficient press, Model T, to replace an old press, Model P, now in use.
Loma's vice president in charge of purchasing has reported that the new press, Model T, will cost $200,000, and will be depreciated over 5 years life using the straight line method.
From an examination of the company's books, you have determined that Model P, which was purchased 5 years ago for $150,000 is being depreciated over a 10-year period. The market value of older press is now $50,000 and has zero salvage value at the end of its 10-year life. 
The company will also be able to reduce operating costs by $45,000 annually over its life.
Loma's income tax rate is 40 percent. If the cost of capital for a project of an all-equity firm is 14 percent, should Loma replace Model P with Model T?
Support your answer by showing the calculation of followings:
a. Net Initial Outlay
b. Annual Cash Flows
c. Net Present Value

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  • CreatedSeptember 19, 2013
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