8-17. Incremental operating cash inflows A firm is considering renewing its equipment to meet increased demand for its product. The cost of equipment modifications is $1.9 million plus $100,000 in installation costs. The firm will depreciate the equipment modifications under MACRS, using a 5-year recovery period. (See Table 3.2 on page 108 for the applicable depreciation percentages.) Additional sales revenue from the renewal should amount to $1.2 million per year, and additional operating expenses and other costs (excluding depreciation and interest) will amount to 40% of additional sales. The firm is subject to a tax rate of 40%. (note: Answer the following questions for each of the next 6 years.)
a. What incremental earnings before depreciation, interest, and taxes will result from the renewal?
b. What incremental net operating profits after taxes will result from the renewal?
c. What incremental operating cash inflows will result from the renewal?
9-20. Payback, NPV, and IRR Rieger International is attempting to evaluate the feasibility of investing $95,000 in a piece of equipment that has a 5-year life. The firm has estimated the cash inflows associated with the proposal as shown in the table at the right. The firm has a 12% cost of capital.
Year (t) Cash inflows (CF t)
a. Calculate the payback period for the proposed investment.
b. Calculate the net present value (NPV) for the proposed investment.
c. Calculate the internal rate of return (IRR), rounded to the nearest whole percent, for the proposed investment.
d. Evaluate the acceptability of the proposed investment using NPV and IRR. What recommendation would you make relative to implementation of the project? Why?
9-25. Integrative-Investment decision Holliday Manufacturing is considering the replacement of an existing machine. The new machine cost $1.2 million and requires installation costs of $150,000. The existing machine can be sold currently for $185,000 before taxes. It is 2 years old, cost $800,000 new, and has a $384,000 book value and a remaining useful life of 5 years. It was being depreciated under MACRS using a 5-year recovery period (see Table 3.2 on page 108) and therefore has the final 4 years of depreciation remaining. If it is held for 5 more years, the machine’s market value at the end of year 5 will be $0. Over its 5 year life, the new machine should reduce operating costs by $350,000 per year. The new machine will be depreciated under MACRS using a 5 year recovery period (see Table 3.2 on page 108). The new machine can be sold for $200,000 net of removal and cleanup costs at the end of 5 years. An increased investment in net working capital of $25,000 will be needed to support operations if the new machine is acquired. Assume that the firm has adequate operating income against which to deduct any loss experienced on the sale of the existing machine. The firm has a 9% cost of capital and is subject to a 40% tax rate.
a. Develop the relevant cash flows needed to analyze the proposed replacement.
b. Determine the net present value (NPV) of the proposal.
c. Determine the (IRR) of the proposal.
d. Make a recommendation to accept or reject the replacement proposal , and justify your answer.
e. What is the highest cost of capital that the firm could have and still accept the proposal? Explain.