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Replacement Decision- Unequal Lives

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Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: Machine 190-3, which has a cost of $190,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $87,000 per year; and Machine 360-6, which has a cost of $360,000, a 6-year life, and after-tax cash flows of $98,300 per year. Knitting machine prices are not expected to rise, because inflation will be offset by cheaper components (microprocessors) used in the machines. Assume that Filkins' cost of capital is 14%. Should the firm replace its old knitting machine and if so, which new machine should it use. Give supporting evidence.

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Please see the attached file.

Since the two machines have unequal lives, we will calculate equivalent annual cash flows

Machine 190-3

Initial investment= $190,000
Annual cash flow= $87,000

We first calculate the Present value of annuity to be received each year years and then subtract the initial outlay to calculate ...

Solution Summary

Answers whether the firm should replace its old knitting machine and if so, which new machine should it use by calculating equivalent annual cash flows for the two alternatives (machines).

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Managerial balance sheet conversation

1) Define and discuss the following:

a) Required Investments
b) Replacement Investments
c) Expansion Investments
d) Diversification Investments
e) How do these differences impact the allocation of capital funds?

2) When applying the NPV rule, how would increased risk be reflected in the computations?

3) Two projects have the expected cash flows shown below. The projects have similar risk characteristics and their cost of capital is 15 percent.

End of Year Project A Project B
Now (11,000,000) (7,000,000)
1 7,000,000 3,000,000
2 3,000,000 1,500,000
3 3,500,000 1,500,000
4 3,000,000 500,000

a) Calculate the NPV for each project. Which project should be accepted if they are independent? If they are mutually exclusive?

4) Discuss how management determines which projects to fund when there is a limit on the total capital available for investment..

5) How do managers make a choice between investments with unequal life spans?

Please convert the attached from one form to a managerial balance sheet form.

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