Should Patch Grove Cabinets Replace the Manual Lathe with a Computerized Lathe?

D

The valuation method that shows the project's impact on the value of the firm is net present value (NPV). To calculate NPV, we need to determine the initial investment outlay, the operating cash flows, and the terminal year cash flows. Then, we discount the cash flows at the WACC. The calculations are as follows:

Step 1: Initial Investment Outlay:

= cost of new machine + proceeds/loss from old machine + change in net working capital (NWC)

= -$90,000 + $30,000 - $6,800 + $5,000 =-$61,800(cash outflow)

Details of calculation:

o Sales price = $30,000inflow

o Tax/tax credit: $6,800outflow

o NWC =current assets -current liabilities = 20,000 "" 25,000 = -5,000 (a decrease in working capital is a source of funds)

Step 2: Operating Cash Flows (years 1-4):Given as$16,800inflow

Step 3: Terminal Value:

=year 5 cash flow + return/use of NWC + proceeds/loss from disposal of new machine + tax/tax credit

=$16,800 - $5,000 + $15,000 + $1,920 =$28,720inflow

Details of calculation:

o Sales price = $15,000inflow

o Tax/tax credit: $1,920inflow

Step 4:Calculate NPV:

NPV = -$61,800 + ($16,800 / 1.131) + ($16,800 / 1.132) +($16,800 / 1.133) +($16,800 / 1.134) +($28,720 / 1.135) =$3,759.

Since the NPV is positive, Patch Grove should replace the old lathe with the new one, because the new lathe will increase the firm's value by the amount of the

NPV, or $3,759.

You may also solve this problem quickly by using the cash flow (CF) key on your calculator.