PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $85 million on equipment with an assumed
life of 5 years and an assumed salvage value of $25 million for tax purposes. The firm uses straight-line depreciation.
The old equipment can be sold today for $70 million. A new modem pool can be installed today for $150 million. This will have a 3-year life and will be depreciated to zero using straight-line depreciation.
The new equipment will enable the firm to increase sales by $23 million per year and decrease operating costs by $11 million per year.
At the end of 3 years, the new equipment will be worthless. Assume the firms tax rate is 30% and the discount rate for projects of this sort is 10%.
What is the net cash flow at time 0 if the old equipment is replaced?
What are the incremental cash flows in years 1, 2, 3?
What is the NPV of the replacement project?
What is the IRR of replacement project?