Covinax Inc plans to buy a new machine to replace an old machine. The new machine is expected to cost $1,300,000. The firm will also incur $150,000 in installation costs. The firm spent $50,000 researching the suitability of the new machine. The new machine has an expected life of five years and will be depreciated straight-line down to zero. Additional investment in working capital of $125,000 will be required at the start of the first year of operation. An additional injection of $70,000 in working capital is expected at the end of year two. At the end of five years the machine will be sold for scrap, with the scrap value expected to be 6% of the initial purchase cost of the machine. The old machine was bought 5 years ago for $500,000 and now has a book value of $35,000. The market value of the old machine is $12,500. Production and sales from the new machine are expected to be 140,000 units per year. Each unit will have a contribution margin of $5 in the first year and selling price inflation will be 6% while variable cost inflation will be 3% thereafter. Prior to the purchase of the machine, total fixed costs per year were $250,000 but with new machine, total fixed costs will rise to $400,000 per year. During year 4, the company is expected to have an increase in maintenance expenditure of $85,000 due to the aging assets. Covinax Inc. has an after-tax cost of capital of 12% which it uses as a discount rate in investment appraisal. The company pays corporate profit tax at an annual rate of 35%. 

Required: 

a) Calculate the net present value of investing in the new machine and advise whether the investment is financially acceptable. 

b) Calculate the internal rate of return of investing in the new machine and advise whether the investment is financially acceptable

Answer rating: 100% (QA)

To calculate the net present value NPV of the investment 1 Calculate the cash inflows from the new m... View the full answer