The firms cost of capital is 13 the cash flows for

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Unformatted text preview: 15,000 15,000 15,000 a. b. c. d. Calculate each project’s payback period. Calculate the net present value (NPV) for each project. Calculate the internal rate of return (IRR) for each project. Draw the net present value profiles for both projects on the same set of axes, and discuss any conflict in ranking that may exist between NPV and IRR. e. Summarize the preferences dictated by each measure, and indicate which project you would recommend. Explain why. LG2 LG3 LG4 9–21 Integrative—Complete investment decision Wells Printing is considering the purchase of a new printing press. The total installed cost of the press is $2.2 million. This outlay would be partially offset by the sale of an existing press. The old press has zero book value, cost $1 million 10 years ago, and can be sold currently for $1.2 million before taxes. As a result of acquisition of the new press, sales in each of the next 5 years are expected to increase by $1.6 million, but product costs (excluding depreciation) will represent 50% of sales. The new press will not affect the firm’s net working capital requirements. The new press will be depreciated under MACRS using a 5-year recovery period (see Table 3.2 on page 100). The firm is subject to a 40% tax rate on both ordinary income and capital gains. Wells Printing’s cost of capital is 11%. (Note: Assume that both the old and the new press will have terminal values of $0 at the end of year 6.) a. Determine the initial investment required by the new press. b. Determine the operating cash inflows attributable to the new press. (Note: Be sure to consider the depreciation in year 6.) c. Determine the payback period. d. Determine the net present value (NPV) and the internal rate of return (IRR) related to the proposed new press. 422 PART 3 Long-Term Investment Decisions e. Make a recommendation to accept or reject the new press, and justify your answer. LG3 LG4 LG5 9–22 CHAPTER 9 CASE Integrative—Investment decision Holliday Manufacturing is considering the replacement of an existing machine. The new machine costs $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 100) and therefore has the final 4 years of depreciation remaining. If it is held until the end of 5 years, the machine’s market value 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 100). The new machine can be sold for $200,000 net of removal and clean up 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 exi...
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