A firm is considering the replacement of an existing machine with a newer model. The old machine was purchased 5 years ago. At that time, its cost was $7,500 and it was expected to have a useful life of 15 years. Its current book value is $5,000 while its current market value is only $1,000
The new machine will have a fully installed cost of $10,000 and an estimated useful life of 10 years, with no expected salvage value or removal costs.
If the new machine is purchased, labor cost savings are estimated to be $1,000 per year, and the cost of waste materials is expected to decline by $2,000 per year.
Assume straight-line depreciation, a corporate tax rate of 30 percent (the same rate applies to gains and losses on sales of capital equipment). The firm’s cost of capital is 20 percent.
a) Determine the initial cash outlay (ICO). (This is the net cash outflow at t=0).
b) Determine the net after-tax incremental cash flows.
c) Determine the NPV for this investment.
d) Determine the IRR for this investment.
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