8. Replacement analysis Aa Aa E Free Spirit Industries Inc. is a company that produces iWidgets, among several other products. Suppose that Free Spirit Industries Inc. considers replacing its old machine used to make iWidgets with a more efficient one, which would cost $2,000 and require $280 annually in operating costs except depreciation. After-tax salvage value of the old machine is $400, while its annual operating costs except depreciation are $1,200. Assume that, regardless of the age of the equipment, Free Spirit Industries Inc.'s sales revenues are fixed at $2,500 and depreciation on the old machine is $400. Assume also that the tax rate is 40% and the project's risk-adjusted cost of capital, r, is the same as weighted average cost of capital (WACC) and equals 10%. Based on the data, net cash flows (NCFs) before replacement are , and they are constant over four years. Although Free Spirit Industries Inc.'s NCFs before replacement are the same over the four-year period, its NCFs after replacement vary annually. The following table shows depreciation rates over four years. Year 1 Year 2 Year 3 Year 4 Depreciation rates 33.33% 44.45% 14.81% 7.41% Complete the following table and calculate incremental cash flows in each year. Hint: Round your answers to the nearest dollar and remember to enter a minus sign if the calculated value is negative. Year 1 Year 2 Year 3 Year 4 Year 0 $2,000 $400 $2,500 $280 $2,500 $280 $2,500 $280 $2,500 $280 New machine cost After-tax salvage value, old machine Sales revenues Operating costs except depreciation ot depreciation Operating income After-tax operating income Net cash flows after replacement (adding back depreciation) Incremental Cash Flows 4 4 A Next evaluate the incremental flows by calculating the net present value (NPV), the internal rate of return (IRR), and the modified IRR (MIRR). Assume again that the cost of financing the new project is the same as the WACC and equals 10%. Hint: Use a spreadsheet program's functions or use a financial calculator for this task. NPV IRR MIRR Evaluation Based on the evaluation, replacing the old equipment appears to be a decision because the MIRR is lower than the IRR the NPV is small the NPV is positive 8. Replacement analysis Aa Aa E Free Spirit Industries Inc. is a company that produces iWidgets, among several other products. Suppose that Free Spirit Industries Inc. considers replacing its old machine used to make iWidgets with a more efficient one, which would cost $2,000 and require $280 annually in operating costs except depreciation. After-tax salvage value of the old machine is $400, while its annual operating costs except depreciation are $1,200. Assume that, regardless of the age of the equipment, Free Spirit Industries Inc.'s sales revenues are fixed at $2,500 and depreciation on the old machine is $400. Assume also that the tax rate is 40% and the project's risk-adjusted cost of capital, r, is the same as weighted average cost of capital (WACC) and equals 10%. Based on the data, net cash flows (NCFs) before replacement are , and they are constant over four years. Although Free Spirit Industries Inc.'s NCFs before replacement are the same over the four-year period, its NCFs after replacement vary annually. The following table shows depreciation rates over four years. Year 1 Year 2 Year 3 Year 4 Depreciation rates 33.33% 44.45% 14.81% 7.41% Complete the following table and calculate incremental cash flows in each year. Hint: Round your answers to the nearest dollar and remember to enter a minus sign if the calculated value is negative. Year 1 Year 2 Year 3 Year 4 Year 0 $2,000 $400 $2,500 $280 $2,500 $280 $2,500 $280 $2,500 $280 New machine cost After-tax salvage value, old machine Sales revenues Operating costs except depreciation ot depreciation Operating income After-tax operating income Net cash flows after replacement (adding back depreciation) Incremental Cash Flows 4 4 A Next evaluate the incremental flows by calculating the net present value (NPV), the internal rate of return (IRR), and the modified IRR (MIRR). Assume again that the cost of financing the new project is the same as the WACC and equals 10%. Hint: Use a spreadsheet program's functions or use a financial calculator for this task. NPV IRR MIRR Evaluation Based on the evaluation, replacing the old equipment appears to be a decision because the MIRR is lower than the IRR the NPV is small the NPV is positive