Warden Co plans to buy a new machine to replace an old one. The cost of the machine, payable immediately, is $1,000,000 and the machine has an expected life of 5 years.
The machine will cause networking capital to decline at the start of the first year of operation. At the end of the five years, the machine will be sold for scrap, with the scrap value expected to be 5% of the initial purchase cost of the machine.
The old machine was bought 9 years ago for $400,000 and was being depreciated over 10 years .
The current market value of the machine is $20,000. Production and sales from the new machine are expected to be 100,000 units per year.
Each unit can be sold for $16 per unit and will incur variable costs of $11 per unit. Selling price inflation is expected to be 3% per year and variable cost will exhibit a similar level of inflation.
Prior to purchase of the machine, total fixed cost per year were $180,000 but with the new machine total fixed cost is $300,000 per year.
Warden Co has an after-tax cost of capital of 11% which it uses as a discount rate in investment appraisal. The company pays profit tax an annual rate an annual rate of 30% per year.
Required:
a) Calculate the NPV of investing in the new machine and advise whether the investment is financially acceptable
b) Calculate the IRR of investing in the new machine and advise whether it is financially acceptable