A large printing company is considering purchasing a new printing press to replace the existing one that cost the company $1 million five years ago.The new machine will cost the company $1.8 million, has an economic life of ten years, and an expected salvage value of $150,000.The old machine can be sold for $200,000 today or could be sold for $10,000 in ten years.Both machines have a CCA rate of 30% and the asset class will remain open and the half-year rule applies in the first year.The company projects that operating profit will increase by $400,000 per year.The company's tax rate is 40% and the cost of capital is 12%.What is the NPV of the replacement decision?

Question

Quizplus · Accepted Answer

The NPV of the replacement decision is $223,204. The calculation is as follows:Initial investment:- Cost of new machine: $1,800,000- Proceeds from sale of old machine: $200,000Net initial investment: $1,600,000Annual cash flows:- Increase in operating profit: $400,000- Depreciation on new machine: $180,000 (1,800,000 x 30% x 10 years / 2)- Depreciation on old machine: $20,000 (1,000,000 x 30% x 10 years / 2)- Tax savings on depreciation: $68,000 (40% x (180,000 - 20,000))Net annual cash flows: $468,000Terminal cash flow:- Salvage value of new machine: $150,000- Sale value of old machine in 10 years: $10,000Net terminal cash flow: $160,000NPV:- Initial investment: -$1,600,000- Annual cash flows: $468,000 x (1 - (1 + 0.12)^-10) / 0.12 = $2,798,400- Terminal cash flow: $160,000 / (1 + 0.12)^10 = $67,804Total NPV: $2,798,400 + $67,804 - $1,600,000 = $223,204

A Large Printing Company Is Considering Purchasing a New Printing