King Fisher Aviation is considering an investment in a new technology for a drone project with a price of $16 million. Their current technology has a book value of $5 million and a market value of $5 million. The new technology is expected to have a five (5) year life, and the old technology has three (3) years left in which it can be expected to be used. If the firm replaces the old technology with the new technology it expects to save $5.7 million in operating costs each year over the next four years. If the firm purchases the new technology, it will also need an investment of $300,000 in net working capital. The required return on the investment is 12 percent, and the tax rate is 39 percent.

What are the NPV and IRR of the decision to replace the old technology?

 

2$ 2$ 16,000,000 5,000,000 5,000,000 Cost of new machine Old machine book value Old machine market value Years of operation Saved operating costs Net working capital Required return Tax rate 2$ 5,700,000 300,000 12% 2$ 39% *Depreciation straight-line Output area: Incremental Buy new machine Keep old machine analysis Initial cash outlay: Purchase new machine Net working capital Sell (buy) old machine Taxes on old machine Total Incremental cash flows Operating expense Depreciation EBT xes Net income OCF Year Cash flow Cash flow Cash flow 1 3 4 NPV IRR