Lowell Inc. is thinking about replacing an old computer with a new one. The new one will cost $1,000,000 and will have a life of FOUR years. The new computer qualifies as 5-year MACRS property.YearsDepreciation rate120%1232%319%1412%It will probably be worth about $340,000 after FOUR years. The old computer is being depreciated at a rate of $110,000 per year. It will be completely written off in FOUR years, at that time it will havezero resale value. We can sell it now for $330,000 after taxes. The new machine will save us $200,000 per year in operating costs. The tax rate (federal plus state) is 25 percent and WACC is 8percent. What is the TOTAL FREE CASH FLOW FOR YEAR 4?Free cash flow = Total Initial Investment + Total annual project CF + Total Salvage Value430,000422,500450,000442,500

Free cash flow is that amount which is earned by the investor from the project. It is the net amount…

Answered: Lowell Inc. is thinking about replacing…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter9: Capital Budgeting And Cash Flow Analysis

Section: Chapter Questions

Problem 5P

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Although the Chen Company’s milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $110,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $19,000 per year. It would have zero salvage value at the end of its life. The project cost of capital is 10%, and its marginal tax rate is 25%. Should Chen buy the new machine?
Friedman Company is considering installing a new IT system. The cost of the new system is estimated to be 2,250,000, but it would produce after-tax savings of 450,000 per year in labor costs. The estimated life of the new system is 10 years, with no salvage value expected. Intrigued by the possibility of saving 450,000 per year and having a more reliable information system, the president of Friedman has asked for an analysis of the projects economic viability. All capital projects are required to earn at least the firms cost of capital, which is 12 percent. Required: 1. Calculate the projects internal rate of return. Should the company acquire the new IT system? 2. Suppose that savings are less than claimed. Calculate the minimum annual cash savings that must be realized for the project to earn a rate equal to the firms cost of capital. Comment on the safety margin that exists, if any. 3. Suppose that the life of the IT system is overestimated by two years. Repeat Requirements 1 and 2 under this assumption. Comment on the usefulness of this information.
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