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Holiday Manufacturing is considering the replacement of an existing machine. The new machine costs $1.2 million and requires installation costs of...

Holiday 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 and therefore has the final 4 years of depreciation remaining. If
held until the end of 5 years, the machine’s market value would 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. 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 existing machine. The firm has a
9% cost of capital and is subject to a 40% tax rate on both ordinary income and
capital gains.
a. Develop the relevant cash flows needed to analyze the proposed
replacement.
b. Determine the net present value (NPV) of the proposal. You can use the
NPV function for this problem.
c. Determine the internal rate of return (IRR) and MIRR of the proposal.
d. What is the highest cost of capital the firm could have and still accept the
proposal? Explain.

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