Corporation may replace a machine. The old machine is fully depreciated and has
ID: 2733660 • Letter: C
Question
Corporation may replace a machine. The old machine is fully depreciated and has no salvage value. It will generate $15,000,000 in revenues and $9,000,000 in operating costs each year for 4 years. A new machine will cost $26,000,000 and will have a salvage value of $6,000,000 at the end of 4 years. It will be fully depreciated to a zero book value on a straight line basis over 4 years. The new machine will generate $19,000,000 in revenues and $7,000,000 in operating costs each year for 4 years. Corporation will have $4,000,000 annually in interest expense as part of the financing. Initial net operating working capital will increase by $100,000 (spare parts inventory for the new machine). There is a $25,000 return of net operating working capital in year 4 when the new machine is salvaged. The investment in net operating working capital is 0 in all other years. The tax rate is 40% and the cost of capital is 11%. Operating costs do not include depreciation or interest expense. a. Find the net present value, internal rate of return, profitability index and payback period. b. Should corporation replace the machine? Explain.