Strong Structures Inc. is considering the replacement of an existing machine. Th
ID: 2803802 • Letter: S
Question
Strong Structures Inc. is considering the replacement of an existing machine. The new machine costs $1,300,000 and requires installation costs of $100,000. The existing machine currently has a salvage value of $210,000 before taxes. It was purchased at a price of $1,000,000 (also its depreciable base) and has been depreciated under the MACRS 5-year recovery period. Over the 7-year economic life of the replacement proposal, the new machine should reduce operating costs by $450,000 per year. The new machine will be depreciated under the MACRS 5-year recovery period and can be sold for $180,000 at the end of its economic life. Also, the new machine will require an increase in net working capital of $40,000. The WACC is 12% and marginal tax rate is 40%. a. What is the Net Initial Investment on the project? b. What are the NCFs? c. What is the Terminal Value? d. What is the NPV, IRR and payback period of the proposed project? Make a recommendation on the project based on these results.
Explanation / Answer
Net initial investment of the project:
Working notes:
After tax salvage value of old machine
NCFs of the project:
Terminal value:
NPV, IRR and payback period
NPV = $3,98,496
IRR = 21%
Payback period
Payback period = 3+(105280/334512)
= 3.3 years
Yes, the project should be accepted as the NPV is positive, IRR is more than the cost of capital and payback period is within the project period.
Cost of new machine $13,00,000 Installation cost $1,00,000 Increase in nwc $40,000 After tax salvage value of old machine -$1,26,000 Initial investment $13,14,000