Question

The G 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 $350 for 6 years. Its current book value is $2,100, and it can be sold on an Internet auction site for $4,500 at this time. Thus, the annual depreciation expense is $2,100/6=$350 per year. If the old steamer is not replaced, it can be sold for $800 at the end of its useful life. G is considering purchasing the Side Steamer 3000, a higher-end steamer, which costs $8,000, and has an estimated useful life of 6 years with an estimated salvage value of $900. 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 40%, and the project cost of capital is 12%. Should it replace the old steamer?

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

Answer 1

The after tax cash flows of the replacement and its NPV are worked out below:
	0	1	2	3	4	5	6
Incremental sales		$         2,000	$         2,000	$          2,000	$        2,000	$       2,000	$        2,000
+Reduction in operating expenses		$         1,400	$         1,400	$          1,400	$        1,400	$       1,400	$        1,400
-Incremental depreciation:
Depreciation of new steamer		$         1,600	$         2,560	$          1,536	$            922	$           922	$           461
Depreciation of old steamer		$             350	$             350	$              350	$            350	$           350	$           350
-Incremental depreciation		$         1,250	$         2,210	$          1,186	$            572	$           572	$           111
=Incremental EBIT		$         2,150	$         1,190	$          2,214	$        2,828	$       2,828	$        3,289
-Taxes at 40%		$             860	$             476	$              886	$        1,131	$       1,131	$        1,316
=Incremental NOPAT		$         1,290	$             714	$          1,328	$        1,697	$       1,697	$        1,974
+Incremental depreciation		$         1,250	$         2,210	$          1,186	$            572	$           572	$           111
=Incremental OCF		$         2,540	$         2,924	$          2,514	$        2,269	$       2,269	$        2,084
-Initial capital expenditure	$        -8,000
+After tax sale value of old equipment = 4500-(4500-2100)*40% =	$         3,540
-Increase in NWC [2900-700)	$        -2,200
+Incremental after tax salvage value at EOY 6 = (900-800)*(1-40%) =							$              60
+Recovery of NWC							$        2,200
After tax project cash flows	-6660	$         2,540	$         2,924	$          2,514	$        2,269	$       2,269	$        4,344
PVIF at 12% [PVIF = 1/1.12^t]	1	0.89286	0.79719	0.71178	0.63552	0.56743	0.50663
PV at 12%	$        -6,660	$         2,268	$         2,331	$          1,790	$        1,442	$       1,287	$        2,201
NPV	$         4,659
AS THE NPV IS POSITIVE THE REPLACEMENT CAN BE MADE.