Reference no: EM132933573
Exercise caseA company produces and sells soft drinks. The management is considering replacing the bottle filling machine currently in use. Significant annual savings can be achieved by purchasing a new (automated) filling machine. The filling machine currently in use has a fiscal book value of € 120,000. When replaced, this machine can be sold for € 120,000. If it is decided to keep this old filling machine, the remaining useful life is 4 years. The residual value of 4 years is nil. When maintaining this old filling machine, € 30,000 is depreciated annually. The purchase price of the new filling machine is € 960,000. Above that, € 40,000 must be paid for installation costs. The residual value at the end of the economic useful life of 4 years is nil. The annual savings on complementary costs (also expenses) that the purchase of the new machine entails compared to maintaining the existing one, amount to € 325,000. The soft drinks factory is fully financed with equity. The management sets the cost of capital at 8% per annum. The corporate tax rate is 40%; the tax due is paid at the end of the relevant year. Government subsidies are not taken into account. All receipts and expenditures occur at the end of each year, except for the net investment amount paid at the beginning of year 1.
Problem a. Calculate the net investment amount if it is decided to replace the old filling machine.
Problem b. Calculate the net after-tax receipts attributable to the replacement project per year.
Problem c. Determine the internal rate of return for this replacement project.
Problem d. Please indicate whether the capital value of this replacement project at the cost of capital of 8% is positive or negative, solely on the basis of the internal rate of return calculated by you.
Problem e. Calculate the net present value of this replacement project.
Problem f. Calculate the payback period for this replacement project. Indicate whether and to what extent the management of the soft drink factory can make a decision based on the results requested above about whether or not to replace the old filling machine, if it is based on:
1. the internal rate of return
2. the net present value