Burton, a manufacturer of snowboards, is considering replacing an existing piece of equipment with a more sophisticated machine. The following information is given.
The proposed machine will cost $120,000 and have installation costs of $15,000. It will be depreciated using a 3 year MACRS recovery schedule. It can be sold for $60,000 after three years of use (at the end of year 3).
The existing machine was purchased two years ago for $90,000 (including installation). It is being depreciated using a 3 year MACRS recovery schedule. It can be sold today for $20,000. It can be used for three more years, but after three more years it will have no market value.
The earnings before taxes and depreciation are as follows:
New machine: Year 1: 133,000, Year 2: 96,000, Year 3: 127,000
Existing machine: Year 1: 84,000, Year 2: 70,000, Year 3: 74,000
Burton pays 40 percent taxes on ordinary income and capital gains, and uses a WACC of 14%.
The maximum payback period allowed is 3 years.
They expect a large increase in sales so their Net Working Capital will increase by $20,000.
a) Calculate the initial investment required for this project.
b) Determine the incremental after-tax operating cash flows
c) Find the terminal cash flow for the project
d) Find the Payback period, NPV, IRR, and MIRR.
e) Should the new machine be purchased? Why or why not?
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