Integrative: Investment decisionHolliday Manufacturing is considering the replacement of an existing machine. The new machine costs

$1.28

million and requires installation costs of

$145,000.

The existing machine can be sold currently for

$180,000

before taxes. It is 2 years old, cost

$809,000

new, and has a

$388,320

book value and a remaining useful life of 5 years. It was being depreciated under MACRS using a 5-year recovery period

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and therefore has the final 4 years of depreciation remaining. If it is held for 5 more years, the machine's market value at the end of year 5 will be

$0.

Over its 5-year life, the new machine should reduce operating costs by

$353,000

per year. The new machine will be depreciated under MACRS using a 5-year recovery period. The new machine can be sold for

$198,000

net of removal and cleanup costs at the end of five years. An increased investment in net working capital of

$24,000

will be needed to support operations if the new machine is acquired. Assume that the firm has adequate operating income against which to deduct any loss experienced on the sale of the existing machine. The firm has a

9.3%

cost of capital and is subject to a

40%

tax rate.

a. Develop the net cash flows needed to analyze the proposed replacement.

b. Determine the net present value (NPV) of the proposal.

c. Determine the internal rate of return (IRR) of the proposal.

d. Make a recommendation to accept or reject the replacement proposal, and justify your answer.

e. What is the highest cost of capital that the firm could have and still accept the proposal?