Question

A pharmaceutical company has some existing semiautomated production equipment that they are considering replacing. This equipment has a present MV of $57,000 and a BV of $30,000. It has five more years of straight-line depreciation available (if kept) of $6,000 per year, at which time its BV would be $0. The estimated MV of the equipment five years from now (in year-zero dollars) is $18,500. The MV rate of increase on this type of equipment has been averaging 3.2% per year. The total operating and maintenance and other related expenses are averaging $27,000 (A$) per year. New automated replacement equipment would be leased. Estimated operating and maintenance and related company expenses for the new equipment are $12,200 per year. The annual leasing cost would be $24,300. The after-tax MARR (with an inflation component) is 9% per year (im); t = 40%, and the analysis period is five years. Based on an after-tax, A$ analysis, should the replacement be made? Base your answer on the actual IRR of the incremental cash flow. The actual IRR of the incremental cash flow is 4.4 %.

Answer 1

Considering the actual IRR of the incremental cash flow is 4.4%, which is below the after-tax MARR of 9%, the replacement of the existing semiautomated production equipment should not be made, as the project does not provide a high enough return.

Step-by-step explanation:

The question asks whether a pharmaceutical company should replace its existing semiautomated production equipment based on a financial analysis. The equipment has a market value (MV) of $57,000 and a book value (BV) of $30,000. It depreciates at a rate of $6,000 per year. The expected MV after five years is $18,500, with an annual MV rate increase of 3.2%. Existing equipment annual expenses average $27,000 (A$), while the new equipment would cost $12,200 in expenses and $24,300 in leasing annually. The after-tax minimum attractive rate of return (MARR), including inflation, is 9%, with a tax rate of 40%. The analysis is for a five-year period, and the actual IRR (Internal Rate of Return) of the incremental cash flow is 4.4%.