Erwin DeLavall, the Plant Manager of Patch Grove Cabinets, is trying to decide whether or not to replace the old manual lathe machine with a new computerized lathe. He thinks the new machine will add value, but is not sure how to quantify his opinion. He asks his colleague, Terri Wharten, for advice. Whartens son just happens to be a Level II CFA candidate. DeLavall and Wharten provide the following information to Whartens son: Company Assumptions: Tax rate: 40% Weighted average cost of capital (WACC): 13% New Machine Assumptions: Cost of (includes shipping and installation): $90,000 Salvage value at end of year 5: $15,000 Depreciation Schedule: MACRS 7-year, with depreciation rates in years 1-5 of 14%, 25%, 17%, 13%, and 9%, respectively Purchase will initially increase current assets by $20,000 and will increase current liabilities by $25,000 Impact on Operating Cash Flows Years 1- 5 (includes depreciation and taxes): $16,800 (assume equal amount each year for simplicity) Old Machine Assumptions: Current Value: $30,000 Book value: $13,000 Book value: $13,000 Which of the following choices is most correct? Patch Grove Cabinets should: A) not replace the old lathe with the new lathe because the new one will decrease the firm’s value by $5,370. B) replace the old lathe with the new lathe because the new one will add $3,760 to the firm’s value. C) replace the old lathe with the new lathe because the new one will add $10,316 to the firm’s value. D) not replace the old lathe with the new lathe because the new one will decrease the firm’s value by $3,132.
A gets me closest to what I calc’d but i probably screwed up somewhere b/c my #'s aren’t exact to the answer. outlay = 90k + NWCinv which i got to be -5000 (the 20k - 25k) = 85k cash flows i want to say are just the 16,800 since it says after tax/depr TNOCF = salvage + NWCinv - T(salT - Bookt) = 15k + (-5000) - .4(15,000 - 19,800) = 11,920 so i threw into my financial calc C0 = -85k C1 =16,800 F4 C2 = 11920 + 16800 = 28720 F1 I = 13% NPV = -19440 old machine profit 30 - 13 = 17k (1-t) = 10,200 so i’d have this thing losing like 9k or so if i just put those 2 #'s together. even in the NPV if i took the 10,200 out of the beginning to get my 1st CF as -74,800, i still get a NPV in the neg 9kish range. where did i go wronggggg? someone clean this up for me.
B agree with most calculations above by bannisja: except initial outlay initial outlay: 90k -5k -30 +6.8 (new machin ,nwc,old machine sale,tax) CF0 = -61800 C1 =16,800 F 4 C2 = 11920 + 16800 = 28720 F 1 I = 13% NPV = 3759.18
sweet- i knew it had to be something easy with the sale of the old machine- i just didn’t know where to put it. so i drop outlay by the sale of the old guy but have to pay taxes on the gain. makes sense, thx for finishing that up for me.