1. Your department is interested in replacing an old, inefficient production machine with a new, more efficient machine. Youve been asked by your supervisor to justify the expense involved in purchasing the new machine. The following is information that has been collected about the situation:

Information Relevant to Both Machines

Sales revenue: $100,000 per year

Useful life of both machines: 5 years

WACC 12%

Tax Rate 40%

Information on the Old Machine

Sale value of the old machine today $15,000

Labor costs per year $12,000

Materials costs per year $3,000

Energy costs per year $20,000

Depreciation expense per year $5,000

Information on the New Machine

Cost of the new machine $60,000

Labor costs per year $2,000

Materials costs per year $1,500

Energy costs per year $10,000

Depreciation expense per year $12,000

What is NPV, IRR and Payback for this project?

Making the Case to Replace an Old Machine with a New, More Efficient Machine Free Cash Flows of Old Machine YEAR Today 1 2 4 5 Sales Revenues Operating Costs Depreciation Operating Income (EBIT) Taxes NOPAT (a) Add back Depreciation Net Free Cash Flow 40% Salvage Value Today Total Net Free Cash Flow Free Cash Flow of New Machine Sal Revenues Operating Costs Depreciation Operating Income (EBIT) Taxes NOPAT (a) Add back Depreciation Net Free Cash Flow 40% Cost of New Machine Today Total Net Free Cash Flow INCREMENTAL CASH FLOWS (b) PROJECT EVALUATION 12% WACC NPV IRR Notes: (a) NOPAT stands for Net Operating Profit After Tax (b) Incremental Cash Flows are equal to Cash Flows associated with the New machine minus cash flows associated with the Old machine