example #6

Make a decision about whether the replacement project should be accepted or rejected. Base your decision on the project's NPV and IRR. You will need to calculate (1) initial cash flow, (2) operating cash flows, and (3) terminal cash flow. Be sure to include the reasoning behind your decision.

Example #6 Replacement Project Analysis The Durst Equipment Company purchased a machine 5 years ago at a cost of $100,000. It had an expected life of 10 years at the time of purchase and an expected sale price of $10,000 at the end of the 10 years. It is being depreciated by the straight-line method toward a salvage value of $10,000. This results in annual depreciation of $9,000. It can be sold today for $65,000 A new machine can be purchased for $150,000 including installation costs. Over its 5-year life, it will reduce cash operating expenses by $50,000 per year. Sales are not expected to change. At the end of its useful life, the machine is estimated to be worthless. MACRS depreciation will be used, and it will be depreciated over a 3-year recovery (rather than its 5-year economic life). The firm's tax rate is 34 percent. The cost of capital is 15 percent. Should the company replace the old machine? Why or why not? MACRS Depreciation Schedule Ownership Class of investment Year 3-year 5-year 7-year 10-year 1 33% 20% 14% 10% 2 2 45 32 25 18 3 15 19 17 14 4 7 12 13 12 5 11 9 9 6 6 9 7 7 9 7 8 4 7 9 7 10 6 11 3