A company is considering the replacement of an old machine with a new machine. The old machine was purchased 3 years ago for $12,000. Additional information relating to these machines is as follows (all cash flows are expressed in nominal terms):
Item Old Machine New Machine
Market Value (now) $6,500 $8,000
Service Life (when purchased) 8 years 5 years
Residual Value in 5 years’ time $0 $ 1,000
Operating Revenue $1,500 $2,000
Depreciation Method Straight line Straight line
Assume that the incremental operating expenses (before depreciation) of buying the new machine are equal to $0, calculate the net present value of replacing the old machine with the new machine. Company tax rate = 30%. The real required rate of return is 7 percent per annum and the anticipated inflation rate is 3 percent per annum.
Required: Produce a spreadsheet to analyze this scenario, where the parameters in yellow above are subject to change or not necessarily fixed.
(a) [2 marks] What is the project NPV of replacing the new machine with the old machine? Produce a graph of this NPV as a function of the real required rate of return.
(b) [1 mark] What is the project NPV of replacing the new machine with the old machine, if inflation turns out to be 5% per annum? Produce a graph of this NPV as a function of the inflation rate.
(c) [1 mark] What is the project NPV of replacing the new machine with the old machine, if the operating revenue from the old machine turns out to be $2,500? Produce a graph of this NPV as a function of revenue from the old machine.
(d) [1 mark] What is the project NPV of replacing the new machine with the old machine, if the operating revenue from the new machine turns out to be $3,000? Produce a graph of this NPV as a function of the revenue from the new machine.
(e) [2 marks] Imagine you are the Chief Financial Officer (CFO) of a company. Using your answers from (a)-(d) above, write a 600 word summary for the Chief Executive Officer (CEO) summarizing whether this project should be accepted or not, and the risks to the company if the project is accepted. The 600 words should include an interpretation of the graphs in parts (a)-(d) above. In addition, perform a scenario analysis (“Best case”, “Most Likely Case”, “Worst Case”) in your 600-word summary