Homework for Chapter 12: Problem #2 in the text (Chapter 12) NOTE: PLEASE USE THE ATTACHED EXCEL FILE TITLED Homework for Chapter 12_Excel” TO SOLVE THE FOLLOWING PROBLEM. Tough Steel, Inc. is a processor of stainless steel products. The firm is considering replacing an old stainless steel tube-making machine for a more cost-effective machine that can meet the firm’s quality standards. • The old machine was acquired 2 years ago at an installed cost of $500,000. It has been depreciated under the MACRS’s 5-year recovery period, and has a remaining economie life of 5 years. It can be sold today for $350.000 before taxes, but if the firm decides to keep it, it can be sold for $100,000 before taxes at the end of year 5. • The first option is Machine A, which can be purchased for $600,000, but will require S30,000 in installation costs.
This machine would be depreciated under the MACRS’s 3- year recovery period. At the end of its economic life, the machine will have a salvage value of $350,000 before taxes. This machine would require an investment in net working capital of $100,000. The second option is Machine B, which can be purchased for S550,000, but requires $20,000 in installation costs. This machine would be depreciated under the MACRS’s 5- year recovery period. At the end of its economic life, the machine would have a salvage value of $330.000 before taxes. This machine requires no investment in net working capital. The firm has estimated the following EBIT for all three machines: | EBIT Year Old machine Machine A Machine B I $90,000 $90,000 $120.000 2 $90,000 $10,000 $20,000 3 $120.000 $150,000 $120.000 4 S150.000 S230,000 $200,000 5 $150.000 $270,000 $200,000 The firm’s WACC is 14% and its tax rate is 40%. a) Calculate the following cash flows for the old machine, machine A. and machine B: . initial investment, • annual after-tax cash flows for each year, and • the terminal cash flow. b) Determine which machine is more profitable for the company based on • the payback period, • discounted payback period, • net present value, • profitability index, internal rate of return, and modified internal rate of return.
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