Developing Relevant Cash Flows for Part-Time Student

Companys Machine Renewal or Replacement Decision

Mclovin, chief financial officer of Part-Time Student Company (PTSC), expects the firms net profits after taxes for the next 5 years to be as shown in the following table.

Year	Net profits after taxes
1	$100,000
2	$150,000
3	$200,000
4	$250,000
5	$320,000

Mclovin is beginning to develop the relevant cash flows needed to analyze whether to renew or replace PTSCs only depreciable asset, a machine that originally cost $30,000, has a current book value of zero, and can now be sold for $20,000. (Note: Because the firms only depreciable asset is fully depreciated---its book value is zero---its expected net profits after taxes equal its operating cash inflows.) He estimates that at the end of 5 years. Mclovin plans to use the following information to develop the relevant cash flows for each of the alternatives.

Alternative 1 Renew the existing machine at a total depreciable cost of $90,000. The renewed machine would have a 5-year usable life and depreciated under MACRS using a 5-year recovery period. Renewing the machine would result in the following projected revenues and expenses (excluding depreciation):

Year	Revenue	Expenses (excluding depreciation)
1	$1,000,000	$801,500
2	1,175,000	884,200
3	1,300,000	918,100
4	1,425,000	943,100
5	1,550,000	968,100

The renewed machine would result in an increased investment of $15,000 in net working capital. At the end of 5 years, the machine could be sold to net $8,000 before taxes.

Alternative 2 Replace the existing machine with a new machine costing $100,000 and requiring installation costs of $10,000. The new machine would have a 5-year usable life and be depreciated under MACRS using a 5-year recovery period. The firms projected revenues and expenses (excluding depreciation), if it acquires the machine, would be as follows:

Year	Revenue	Expenses(excluding depreciation)
1	$1,000,000	$764,500
2	1,175,000	839,800
3	1,300,000	914,900
4	1,425,000	989,900
5	1,550,000	998,900

The new machine would result in an increased investment of $22,000 in net working capital. At the end of 5 years, the new machine could be sold to net $25,000 before taxes. The weighted average cost of capital is 10% and the marginal tax rate is 40%.

Find the NPV, IRR, MIRR, payback and discounted payback for both alternatives. Which alternative should be selected? Explain.