Reference no: EM133227559

Paprika Inc is considering buying a new machine that completely automates the process of making its leather-free shoes. The machine will replace an older machine that required human labour. The new, automated machine costs $400,000 and has associated shipping and installation charges of $20,000 in total. It is expected that this new machine will have an economic life of 5 years after which it could be sold for $20,000 (sold as scrap parts). It is expected that this new machine, being completely automated will increase production speed and hence revenues would be expected to increase by $40,000 per year. If Paprika Inc replaces the old machine with the new one, this would require a once-off increase in net working capital of $40,000 that will be fully recovered at completion. The old machine cost $320,000 three years ago and had a useful life of 8 years. It could be sold today for $150,000. The old machine requires annual maintenance of $7,500 per year as well as a dedicated operator who receives $30,000 per year. Depreciation for both machines is estimated with the straight-line method. Paprika is incorporated in the Seattle and pays no tax, hence there is no capital gain tax imposed on sales of assets. The firm's cost of capital is 12%.

1. Calculate the total Free Cash Flow in Year O. Show all calculations.

2. Calculate the total Free Cash Flow every year from Year 1 to Year 4. Show all calculations.

3. Calculate the total Free Cash Flow in Year 5. Show all calculations.

4. Should Paprika replace the old machine with the new machine? Explain.

5. At what required rate of return (%) would Paprika be indifferent between keeping the old machine and buying the new one?