Orgler Label Company is thinking about replacing an existing

Orgler Label Company is thinking about replacing an existing press. The     existing press was purchased 6 years ago for $155,000 with a salvage value of $8,000. It will last for four more years and it is expected to be worthless at that time.   It can be sold today for $50,000.

                  A new high-speed press can be purchased for $195,000 with an expected salvage value of $30,000 at the end of its four-year life.

            Orgler current revenue is $2,000,000 and is expected grow 6% per annum. The new machine would have increased current revenue to $2,200,000. Firm revenue will continue to grow by 6% per annum if they acquire the new machine. Orgler average collection period is 55 days and pays it bills after 25 days.   Orgler has a gross profit margin of 28%. The new press will increase labor costs by $9,000 per year.   Orgler uses 9% for its cost of capital and has an ordinary income tax rate of 30%. The project will be 50% financed with a 7% 3-year loan. The firm uses straight line depreciation.   Calculate the project’s NPV.   

Solution

First of all let us calculate Book value of existing machine

Depreciation on old machine = cost less salvage value/ Expected useful life

=155000-8000/10

=14700$

Depreciation for 6 years = 14700*6 = 88200$

Book value of old machine = 155000-88200 = 66800$

Thus cash flow from old machine if it is sold today

Now we will calculate Installment if new machine is purchased

Installment = Loan/PVIFA(7%,3)

=(195000*50%) / 2.624

=97500/2.624

=37152.5$

Statement showing bifercation of intrest and principle

Now let us calculate depreciation

=195000-30000/4 = 41250$

Incremental depreciation = 41250-14700 = 26550$

Statement showing NPV

Thus NPV = 26127$