A company is evaluating a replacement project of an old machine with a new more efficient one.
The old machine was purchased 3 years ago for $1,500,000 and was being depreciated using MACRS 5-year class (20%, 32%, 19.2%, 11.52%, 11.52% and 5.76%). This old machine can be sold for $500,000 at this time. However, if the machine is not replaced, it can be sold for $100,000, four years from now. Currently, the old machine produces annual sales of $1,500,000; its annual operating cost is $700,000.
The new machine will cost $2,000,000 and falls into MACRS 3-year class (33%, 45%, 15% and 7%). This new machine will produces annual sales of $2,500,000, and its annual operating cost will be $1,000,000. This machine can be sold for $250,000 at the end of the 4-year period.
The project has an expected life of 4 years.
The replacement of the old machine with the new one, will require inventories increase by $250,000, while at the same time the accounts payables will increase by $75,000.
The tax rate is 40% and the cost of capital is 12%.
The company hired a consultant two years ago to conduct a feasibility study about this replacement project, which cost them $1,000,000 at that time. The interest expense on the debt component of the capital required for this project will be $175,000 annually.
a) What is the initial investment CF0?
b) What is the CF1 (The cash flow to be used in NPV calculation)?
c) What is the non-operating cash flow for year 4?
d) What is the CF4 (The cash flow to be used in NPV calculation)?
e) What is the NPV of the project?