Question
1. Premium Pie Company needs to purchase a new baking oven to replace an older oven that requires too much energy to run. The industrial
1. Premium Pie Company needs to purchase a new baking oven to replace an older oven that requires too much energy to run. The industrial size oven will cost $1,200,000. The oven will be depreciated on a straight-line basis over its six-year useful life with no salvage value. The old oven cost the company $800,000 just four years ago. The old oven is being depreciated on a straight-line basis over its expected ten-year useful life. (That is, the old oven is expected to last six more years if it is not replaced now.) Due to changes in fuel costs, the old oven may only be sold today for $100,000. The new oven will allow the company to expand, increasing sales by $300,000 per year. Expenses will also decrease by $50,000 per year due to the more energy efficient design of the new oven. To expand, the company need additional $100,000 of net working capital at the beginning. Premium Pie company is in the 40% marginal tax bracket and has a required rate of 10%. (tip: Consider capital gain(loss) as regular income(loss) for tax purpose)
1. Fill the blanks.
2. Calculate the net present value(NPV) and internal rate of return(IRR) of replacing the existing machine (tip: IRR is xx.03%. Find only those two digits.)
year O year 1-year 5 year 6 Purchase Price (51.200.0002 Sale of old machine Tax savings from sale of old b Increased Sales $300.000 $300.000 Reduced costs 59.000 50.000 Increased depreciation so c. 2 fold machine) d. (new machine) $200.000 $200.000 Net savings before tax) Taxes (40%) (22.000 (22.0002 Net Income A in Net Working Capital s. O b. Free Cash Flow (CFFA) $358.000
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