Holiday Manufacturing is considering the replacement of an existing machine. The new machine costs $1.2 million and

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Holiday Manufacturing is considering the replacement of an existing machine. The new machine costs $1.2 million and requires installation costs of $150,000. The existing machine can be sold currently for S 185,000 before taxes. It is 2 years old, cost $800,000 new; and has a $384,000 book value and a remaining useful life of 5 years. It was being depreciated under MACRS using a 5-year recovery period and therefore has the final 4 years of depreciation remaining. If it is held for S more years, the machine’s market value at the end of year S will be $0. Over its 5-year life, the new machine should reduce operating costs by $350,000 per year. The new machine will be depreciated under MACKS using a 5-year recovery period. The new machine can be sold for $200,000 net of removal and cleanup costs at the end of S years. An increased investment in net working capital of $25,000 will be needed to support operations if the new machine is acquired. Assume that the firm has adequate operating income against which to deduct any loss experienced on the sale of the existing machine. The firm has a 9% cost of capital and is subject to a 40% tax rate.

a. Develop the relevant cash flows needed to analyze the proposed replacement.

b. Determine the net present value (N.PV) of the proposal.

c. Determine the internal rate of return (ERR) of the proposal.

d. Make a recommendation to accept or reject the replacement proposal, and justify your answer.

e. What is the highest cost of capital that the firm could have and still accept the proposal? Explain.


Net Present Value
What is NPV? The net present value is an important tool for capital budgeting decision to assess that an investment in a project is worthwhile or not? The net present value of a project is calculated before taking up the investment decision at...
Internal Rate of Return
Internal Rate of Return of IRR is a capital budgeting tool that is used to assess the viability of an investment opportunity. IRR is the true rate of return that a project is capable of generating. It is a metric that tells you about the investment...
Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of...
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Principles of managerial finance

ISBN: 978-0132479547

12th edition

Authors: Lawrence J Gitman, Chad J Zutter

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