Hillsdale Media is a specialty kitchen cabinet maker that produces cabinets to order. Currently the...
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Hillsdale Media is a specialty kitchen cabinet maker that produces cabinets to order. Currently the company uses a machinery that has 5 years of its economic life remaining. The current book value of the machinery is 4 million euros, while the market value is estimated as 2.8 million euros, while both the accounting salvage value and market value is estimated to be 0 euros in five years from now. Current annual EBITDA is estimated to be 1.5 million euros if the company continues to use the old machine.
Now, when the old machine is replaced by a new one it is expected that the annual EBITDA will increase to 2.3 million euros due to gains in efficiency. The purchase price of a new machine is 8 million euros. The new machine will also have an economic life of 5 years, after which it is expected that the accounting salvage value is 0 euros but there exists an after market for the machine and the estimated market value is 15% of the purchase price.
The company has a marginal tax rate of 24% for both earnings and capital gains. The cost of capital for replacement decisions is 7%.
Questions: a) Estimate the incremental cash flows from the replacement decision
b) Use NPV and IRR to decide if Hillside Media should make the replacement
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