The company is considering the purchase of new equipment to replace some old, existing equipment. The old equipment is fully depreciated and has a current market value of $2.4M. The new equipment...

The company is considering the purchase of new equipment to replace some old, existing equipment. The old equipment is fully depreciated and has a current market value of $2.4M. The new equipment costs $20 M and will be depreciated on the diminishing value basis at 15% per annum. The equipment is used to produce items with constant annual revenues of $36M. Current costs (using the old equipment) are $8M per year. The new equipment will not change the expected revenues (they will remain at $36 M per year), but will allow the company to cut costs by $2.5M per year. The project is expected to last for 7 years, at which time the new equipment would be worth $10M. If the old equipment is kept, it will be worthless in 7 years. The company's marginal tax rate is 30%. The required rate of return is 12.5%.

A) The chairman of the board argues that the new equipment does not add value as the expected revenues remain the same regardless of whether the new equipment or the old equipment is used. So, there is no need to do any calculations. Just reject the project based on this fact alone. Do you agree or disagree? If you disagree, write a short paragraph explaining why an analysis is needed.
B) Calculate the NPV. Should the project be accepted? Justify your answer.



(Your written explanation for parts A and B together should not exceed 250 words).