You are a financial analyst at the Humongous Project Company (HPC). Four years ago, HPC purchased a
Question:
You are a financial analyst at the Humongous Project Company (HPC). Four years ago, HPC purchased a machine at an installed cost of $70,000; the machine is being depreciated using MACRS with a 5-year recovery period. The machine has six years of useful life remaining and could be sold today for $403,000 after removal and cleanup costs.
A new, more efficient machine can be purchased for $280,000. The new machine would cost $10,000 to install and would have a useful life of 6 years; it would be depreciated using a 5-year MACRS depreciation recovery schedule. At the end of the six years, it would have an estimated salvage value of $60,000.
Because of the increased output of the new machine, the firm’s sales would rise, with a corresponding increase in accounts receivable of $40,000, an increase in inventories of $25,000, and an increase in accounts payable of $35,000.
The following chart shows the expected revenues and operating costs for the new and old machine for each year.
New Machine | Old Machine |
Year | Revenue | Operating Costs | Revenue | Operating Costs |
1 | $265,000 | $105,000 | $140,000 | 61,000 |
2 | $275,000 | $115,000 | $144,000 | 62,000 |
3 | $285,000 | $125,000 | $148,000 | $63,000 |
4 | $295,000 | $135,000 | $150,000 | $64,000 |
5 | $280,000 | $140,000 | $146,000 | $62,000 |
6 | $275,000 | $145,000 | $143,000 | $60,000 |
HPC’s applicable tax rate is 21%. HPC’s weighted-average-cost-of-capital is 14%. HPC uses a 4-year payback period rule, along with NPV, PI, and IRR.
The MACRS 5-year property depreciation schedules are as follows:
Year | Recovery Percentage |
1 | 20% |
2 | 32% |
3 | 19% |
4 | 12% |
5 | 12% |
6 | 5% |
Determine the initial investment associated with the proposed investment decision.
Calculate the incremental operating cash flows for years 1 through 6 associated with the proposed replacement.
Calculate the terminal cash flow associated with the proposed replacement decision.
Show the relevant cash flows on a timeline.
Compute the NPV, IRR, Profitability Index, and payback period for this project. Should HPC accept this replacement decision? Why or why not?
Expert Answer:
SOLUTION To determine the initial investment associated with the proposed investment decision we need to consider the cost of the new machine installation costs and the removal and cleanup costs of th... View the full answer
Principles Of Managerial Finance
ISBN: 978-0136119463
13th Edition
Authors: Lawrence J. Gitman, Chad J. Zutter
