Johnny Farming is considering replacing an old motorised tractor with a modern unit that is priced at
Question:
Johnny Farming is considering replacing an old motorised tractor with a modern unit that is priced at $750,000 and requires extra net working capital equal to 5% of the tractor purchase price. A quantity surveyor (licensed tax depreciation professional) establishes that the new unit can be depreciated at $100,000 per annum straight-line till zero over an effective life of 8 years. The final year depreciation will be the reminder of book value remaining and no salvage value is anticipated.
Annual revenue from the swap in machines is expected to increase in the first year of operation by $60,000, growing at 15% per annum after. Extra net working capital will have to be provided equal to 6% of the revenue increase. Fixed costs associated with machine operation will increase by $3,000 p.a. as more skilled staff are need for the new tractor. there is a $2,000 p.a. saving in maintenance and service costs as the new machine is more efficient that the old. The new tractor will require extra insurance coverage of $800 p.a. more than the old tractor. In the fourth year of operating the new tractor, a scheduled parts replacement costing $20,000 will occur. There is no scheduled parts replacement remaining for the old tractor.
The old tractor has an effective life of 20 years and was purchased 12 years ago for $800,000. The old tractor depreciates straight-line at 5% of it’s original BV each year to zero. The tractor can be sold today for $300,000. Johnny’s tax rate is 47%, he has a cost of capital of 6% and assume a complete recovery of net working capital at project end. The new tractor requires shipping and assembly equal to 3% of it’s purchase price.
What is The inital investment NCF? What is The Year 4 NCF and the final Year NCF?
Applying the NPV and IRR decision rules, should I reject/ accept this project?
If the cost of capital falls by 75 basis points, how much the new NPV will be ? and the project recommendation is ACCEPT /REJECT .
Reset the cost of capital back to 6%
At what scheduled parts replacement (-$20,000 at present), will the project break-even with 0 NPV ?
Expert Answer:
The initial investment NCF Net Cash Flow is the cash outflow required to purchase and set up the new tractor minus the cash inflow from selling the old tractor It is calculated as follows Cost of new ... View the full answer
