The Auraria Pet Foods Company is considering the purchase of more flexible equipment that will allow them
Question:
The Auraria Pet Foods Company is considering the purchase of more flexible equipment that will allow them to create new products and will also be less expensive to operate than the current machinery. The existing equipment could be sold for $70,000 after taxes. As of today, management forecasts call for after-tax cash flows of $32,000 next year if the current machinery is retained. The cash flows are expected to increase at a rate of 6% per year for the next five years. The new machinery under consideration has a price of $90,000. It would be expected to produce cash flows of $35,000 next year, and the cash flows would grow by 8% per year for the next five years. The firm's WACC is 15%.
a. Calculate the net present value, IRR, and MIRR of the existing equipment. If the new equipment was not available, would it make more sense to keep the existing equipment or to sell it?
b. Calculate the net present value, IRR, and MIRR of the new equipment. If the new equipment is treated as a stand-alone investment, would it make sense to make the investment?
c. If you had to choose between keeping the existing equipment and investing in the new equipment, which would you choose? Make the comparison by looking at both the NPVs and IRRs.
d. Calculate the incremental cost and annual after-tax cash flows if the new equipment is purchased. Evaluate the investment in the new equipment as a replacement project. Would you make the investment? Use the NPV, IRR, and MIRR to explain your decision.
e. Compare the NPV of the incremental cash flows to the difference between the NPVs of the new and old machines (NPVNew - NPVOld). What conclusions can you draw from this comparison? Is evaluating the incremental cash flows essentially the same as evaluating each project separately and then comparing the NPVs?
f. At what discount rate would you be indifferent between keeping the existing equipment and purchasing the new equipment? Calculate the crossover rate using the IRR function. Now, use the Goal Seek tool to determine the answer. Are they the same?
Net Present ValueWhat 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... Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...
Step by Step Answer:
Auraria Pet Foods Company IO ATCF 1 ATCF 2 ATCF 3 ATCF 4 ATCF 5 New Machine 90000 35000 37800 40824 44090 47617 Old Machine 70000 32000 33920 35955 38...View the full answer
Financial Analysis with Microsoft Excel
ISBN: 978-1111826246
6th edition
Authors: Timothy R. Mayes, Todd M. Shank
