Question
1. Baba Rafi wants to replace their existing BBQ machine in front of NSU gate 1 with a newly improved and more efficient equipment. The
1. Baba Rafi wants to replace their existing BBQ machine in front of NSU gate 1 with a newly improved and more efficient equipment. The new machine will include grilling, as well as baking options with a burner. This means Baba Rafi is considering the introduction of flat bread pizzas. The old one costs $500,000 and was bought 5 years back. The old machine should run for 5 more years. Today salvage value of the old machine is $265,000 and from 5 years from now it should be $10,000. Currently the old truck uses the straight-line method of depreciation. The replacement will also require an initial investment in current assets of $20,000, of which $10,000 will be coming from short-term creditors (hint: working capital = CA-CL).
The new BBQ machine, which will be in operation for 5 years, will cost the company $650,000. For the new equipment the company will follow a three years MACRS depreciation schedule and the depreciation percentage every year for the new truck is given below.
Year 1 | Year 2 | Year 3 | Year 4 |
.3333 | .4444 | .1482 | .0741 |
Tax rate is 40%
Required
- Using the above-mentioned information give your justification whether Baba Rafi should replace its current BBQ machine with the new composite machine using the NPV. The WACC is 12% Answer:
Year | 1 | 2 | 3 | 4 | 5 |
Cost Savings | |||||
Depr. | |||||
New | |||||
Old | |||||
Net Dep | |||||
EBIT | |||||
Taxes | |||||
NI |
Year | 0 | 1 | 2 | 3 | 4 | 5 |
OCF | ||||||
NCS | ||||||
D In NWC | ||||||
FCF |
2. Baba Rafi is considering opening a small sandwich outlet inside the NSU campus. It will require an initial investment of $20,000 and throughout the next 5 years the project will potentially generate free cash flows in the following form:
0 | 1 | 2 | 3 | 4 | 5 |
-20,000 | 6000 | 10000 | -4000 | 3500 | 6500 |
Now, as we can see an unconventional cash flow in year 3, please calculate the MIRR to decide whether Baba Rafi should invest in this project or not? The required rate of return is the WACC calculated in problem 1.
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