Question

The Gilbert Instrument Corporation is considering replacing the wood steamer it currently uses to shape guitar sides. The steamer has 6 years of remaining life. If kept, the steamer will have depreciation expenses of $650 for 5 years and $305 for the sixth year. Its current book value is $3,555, and it can be sold on an Internet auction site for $4,125 at this time. If the old steamer is not replaced, it can be sold for $800 at the end of its useful life.

Gilbert is considering purchasing the Side Steamer 3000, a higher-end steamer, which costs $11,200, and has an estimated useful life of 6 years with an estimated salvage value of $1,200. This steamer falls into the MACRS 5-years class, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The new steamer is faster and allows for an output expansion, so sales would rise by $2,000 per year; the new machine's much greater efficiency would reduce operating expenses by $1,400 per year. To support the greater sales, the new machine would require that inventories increase by $2,900, but accounts payable would simultaneously increase by $700. Gilbert's marginal federal-plus-state tax rate is 25%, and the project cost of capital is 10%.

What is the NPV of the project? Do not round intermediate calculations. Round your answer to the nearest dollar.

Answer 1

ANSWER

COMPUTE AFTER TAX SALES REVENUE INCREASE AS FOLLOWS -
PURCHASE PRICE			-11200
SALE OF OLD MACHINE			4125
TAX ON SALE OF OLD MACHINE(4150-3575)x40%			-142.5
NET OPERATING WORKING CAPITAL (-2900+700)			-2200
CASH FLOW YEAR 0			-9418
SALES INCREASE			2000
COST DECREASE			1400
TOTAL INCREASE IN PRE TAX REVENUE			3400
LESS;TAX(3400x25%)			850
AFTER TAX SALES REVENUE INCREASE (3400-1360)			2550
COMPUTE DEPRECIATION TAX SAVINGS AS FOLLOWS-
			YEAR 1	YEAR 2	YEAR 3	YEAR 4	YEAR 5	YEAR 6
NEW MACHINE DEPRECIATION (AS PER RATES GIVEN)(A)			-2240	-3584	-2150.4	-1290.24	-1290.24	-645.12
LESS: OLD MACHINE DEPRECIATION			-650	-650	-650	-650	-650	-305
CHANGE IN DEPRECIATION (A-B)			-2890	-4234	-2800.4	-1940	-1940	-950
DEPRECIATION TAX SAVINGS ( C x 40%)			-722.5	-1058.5	-700.1	-485.06	-485.06	-237.53
COMPUTE NPV AS FOLLOWS -
			YEAR 0	YEAR 1	YEAR 2	YEAR 3	YEAR 4	YEAR 5	YEAR 6
NET INVESTMENT			-9417.5
AFTER TAX SALES REVENUE INCREASE				2550	2550	2550	2550	2550	2550
DEPRECIATION TAX SAVINGS ( 25%)				-722.5	-1058.5	-700.1	-485.06	-485.06	-237.53
WORKING CAPITALRECOVERY									-2240
AFTER TAX VALUE OF NEW MACHINE ((1200 x (1-0.25))									900
OPPORTUNITY COST OF NEW MACHINE ((800 x (1-0.25))									-600
PROJECT CASH FLOWS			-9417.5	1827.5	1491.5	1849.9	2064.94	2064.94	372.47
PVF @10%			1	0.90909	0.82645	0.75131	0.68301	0.62092	0.56447
PRESENT VALUES OF CASH FLOWS			-9417.5	1661	1233	1390	1410	1282	210
NPV (11,170 - 9280)			-2231
AS THE NPV IS NEGATIVE THEREFORE REJECT THE NEW MACHINE PROPOSAL

PLEASE APPRECIATE THE WORK