Reference no: EM133075509
Incorporate Working Capital Into Capital Budgeting
The Olney Company purchased a machine 3 years ago at a cost of $150,000. It had an expected life of 10 years at the time of purchase and an expected salvage value of $5,000. The existing machine costs $54,000 year to run and generates $1,000,000 a year in revenue with a gross profit margin of 20%. The old machine can be sold today for $55,000 and the expectation is that it can be sold for $7,500 in 7 years.
A new machine with a 7 year life can be purchased for $225,000. Cash operating expenses will be $65,000 per year. The new machine will generate revenue of $1,100,000 per annum in the first three years of operation and then revenue of the new machine will increase to $1,200,000 per annum for the balance of machine's life. The machine has a gross profit margin of 23% due to fewer defects. At the end of its useful life, the machine will have no value. The firm's tax rate is 25 percent. Straight-line depreciation is used for all assets. The firm's WACC is 12 percent. The firm has an ACP of 63 days and pays its bills after 25 days.
Calculate project's NPV and IRR.