Reference no: EM132957821
Question - Capital budgeting (replacement decision) - The company is evaluating if the replacement of an old machine is economically feasible. You have the following information:
Old machine:
The book value of the old machine is 1.2 million which is also the price it can be sold today.
Remaining economic life is 5 years
Annual EBITDA is $0.5 million
Both book value and market value in 5 years is 0.
Annual depreciation is $0.24 million
New machine:
Purchase price is $2.5 million
Economic life 5 years
Annual EBITDA is $1.3 million (increase by $0.8 million compared to old machine)
Both book and market values are 0 when project ends.
Company tax rate is 25% on both profits and capital gains. The cost of capital for the company is 12%. Note that there are no changes related to net working capital.
Replacement decision means also that the company has to invest into net working capital. This investment is 0.3 million euros but we can assume that that investment is fully recovered when project ends.
Required -
1) Estimate the total cash outflow when replacement is made (t=0).
2) Estimate the changes in operating cash flow (OCF) of the first year and assume that this stays the same for the remaining years.
3) Estimate the terminal cash flow.
4) Compute NPV and explain if the company should make this investment or not.