Considering the replacement of existing machine

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Reference no: EM131933690

Foenum Corp is considering the replacement of an existing machine. The existing machine has a market value today of $360,000 and has a remaining book value of $180,000. If kept, it will continue to be depreciated on a straight-line basis over the coming 6 years to a book value of zero. However, it is expected to have a market value of $80,000 at the end of the 6 years. There is no net working capital recovery for this machine. If kept, the machine will be sold off after 6 years.

The new machine that Foenum Corp is considering as a replacement costs $850,000 today, and it has an expected useful life of 6 years. If purchased, this machine will require an additional expenditure of $50,000 upfront for shipping, modification, and installation. Also, it will require an initial outlay of $35,000 for additional working capital (which is expected to be fully recovered when the machine is sold at the end of 6 years). For tax purposes, this machine will be fully depreciated straight-line on an 8-year schedule. The expected market value of the machine at the end of the 6 years is $137,500.

The replacement of the existing machine with the new one is expected to lead to an increment in the firm’s annual sales revenue to the extent of $280,000. However, annual operating costs (other than depreciation) will also be higher, to the extent of $80,000. The firm faces a marginal tax rate of 40%, and has an estimated cost of capital of 12.55%. What are the IRR and NPV of the potential replacement decision, and should Foenum Corp replace the existing machine based on these calculations? Explain.

Reference no: EM131933690

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