Developing Relevant Cash Flows Assignments : Time Student
Company’s Machine Renewal or Replacement Decision
Mclovin, chief financial officer of Part-Time Student Company (PTSC), expects the firm’s net profits after taxes for the next 5
years to be as shown in the following table. : Business and Finance Homework Help
Year Net profits after taxes
Mclovin is beginning to develop the relevant cash flows needed to analyze whether to renew or replace PTSC’s only
depreciable asset, a machine that originally cost $30,000, has a current book value of zero, and can now be sold for $20,000. (Note:
Because the firm’s only depreciable asset is fully depreciated—its book value is zero—its expected net profits after taxes equal its
operating cash inflows.) He estimates that at the end of 5 years. Mclovin plans to use the following information to develop the
relevant cash flows for each of the alternatives.
Alternative 1 Renew the existing machine at a total depreciable cost of $90,000. The renewed machine would have a 5-year
usable life and depreciated under MACRS using a 5-year recovery period. Renewing the machine would result in the following
projected revenues and expenses (excluding depreciation):
Year Revenue Expenses
1 $1,000,000 $801,500
2 1,175,000 884,200
3 1,300,000 918,100
4 1,425,000 943,100
5 1,550,000 968,100
The renewed machine would result in an increased investment of $15,000 in net working capital. At the end of 5 years, the machine
could be sold to net $8,000 before taxes.
Alternative 2 Replace the existing machine with a new machine costing $100,000 and requiring installation costs of $10,000.
The new machine would have a 5-year usable life and be depreciated under MACRS using a 5-year recovery period. The firm’s
projected revenues and expenses (excluding depreciation), if it acquires the machine, would be as follows:
Year Revenue Expenses(excluding depreciation)
1 $1,000,000 $764,500
2 1,175,000 839,800
3 1,300,000 914,900
4 1,425,000 989,900
5 1,550,000 998,900
The new machine would result in an increased investment of $22,000 in net working capital. At the end of 5 years, the new machine
could be sold to net $25,000 before taxes. The weighted average cost of capital will be given to your group when you email me or
provide the names of your group to me in class; the marginal tax rate is 40%.
Find the NPV, IRR, MIRR, payback and discounted payback for both alternatives. Which alternative should be selected? Explain.
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