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1. Premium Pie Company needs to purchase a new baking oven to replace an older oven that
requires too much energy to run. The industrial size oven will cost $1,200,000. The oven
will be depreciated on a straight-line basis over its six-year useful life. The old oven cost the
company $800,000 just four years ago. The old oven is being depreciated on a straight-line
basis over its expected ten-year useful life. (That is, the old oven is expected to last six more
years if it is not replaced now.) Due to changes in fuel costs, the old oven may only be sold
today for $100,000. The new oven will allow the company to expand, increasing sales by
$300,000 per year. Expenses will also decrease by $50,000 per year due to the more energy
efficient design of the new oven. Premium Pie Company is in the 40% marginal tax bracket
and has a required rate of return of 10%.
A. Calculate the net present value and internal rate of return of replacing the existing
machine
B. Explain the impact on NPV of the following:
I. Required rate of return increases
II. Operating costs of new machine are increased
III. Existing machine sold for less
2. Is it possible for a company that has negative net income, negative operating cash flow, and
negative free cash flow to end the year with an increase in cash and an increase in stock
price? Explain your answer. (Please write between 300-500 words)
