Developing Relevant Cash Flows for Part-Time Student Company's Machine Renewal or Replacement Decision Mclovin, chief financial officer of Part-Time Student Company (PTSC), expects the firm's 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 PTSC's 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 firm's 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 41,425,000 943,100 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. eplace 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 firm's 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 31,300,000 914,900 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. CAPITAL BUDGETING CASH FLOW STATEMENT REVENUE LESS CASH EXPENSES -PROFIT BEFORE DEPRECIATION AND TAXES (PBDT) LESS DEPRECIATION =PROFIT BEFORE TAX LESS TAXES -PROFIT AFTER TAX (PAT) +DEPRECIATION -CASH FLOW (CF) LESS EXISTING CF -INCREMENTAL CF ***THE LAST 2 LINES ARE FOR REPLACEMENT PROJECTS Also the MACRS Depreciation schedule for a 5 year asset is Year 20% Year 2 32 19 Year 4 12 Year 5 Year 6 Vear 3 Developing Relevant Cash Flows for Part-Time Student Company's Machine Renewal or Replacement Decision Mclovin, chief financial officer of Part-Time Student Company (PTSC), expects the firm's 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 PTSC's 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 firm's 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 41,425,000 943,100 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. eplace 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 firm's 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 31,300,000 914,900 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. CAPITAL BUDGETING CASH FLOW STATEMENT REVENUE LESS CASH EXPENSES -PROFIT BEFORE DEPRECIATION AND TAXES (PBDT) LESS DEPRECIATION =PROFIT BEFORE TAX LESS TAXES -PROFIT AFTER TAX (PAT) +DEPRECIATION -CASH FLOW (CF) LESS EXISTING CF -INCREMENTAL CF ***THE LAST 2 LINES ARE FOR REPLACEMENT PROJECTS Also the MACRS Depreciation schedule for a 5 year asset is Year 20% Year 2 32 19 Year 4 12 Year 5 Year 6 Vear 3