Question

HL Construction Co. plans to replace one of its manufacturing equipment for a newer more technology-advance one. The new equipment has a purchase price of $8,000 and will be depreciated as a 7-year class for MACRS. Installation costs for the new equipment are $200. It is estimated that this equipment can be sold in 5 years (end of project) for $5,000. This new equipment is more efficient than the existing one and thus savings before taxes using the new equipment are $4,000 a year. Because of the advance technology of new equipment, there will be a reduction in inventory of $400 today and which will be reverted at the end of the project in year 5.

This existing equipment was purchase 2 years ago at a base price of $3,000. Installation costs at the time for this old equipment were $100. The existing equipment is considered also 7-year class for MACRS. The existing equipment can be sold today for $1,000 and for $0 in 5 years. The company's marginal tax rate is 30% and the cost of capital is 10%.

Answer the 5 questions below.

MACRS Fixed Annual Expense Percentages by Recovery Class
Year	3-Year	5-Year	7-Year	10-Year	15-Year
1	33.33%	20.00%	14.29%	10.00%	5.00%
2	44.45%	32.00%	24.49%	18.00%	9.50%
3	14.81%	19.20%	17.49%	14.40%	8.55%
4	7.41%	11.52%	12.49%	11.52%	7.70%
5		11.52%	8.93%	9.22%	6.93%
6		5.76%	8.93%	7.37%	6.23%
7			8.93%	6.55%	5.90%
8			4.45%	6.55%	5.90%
9				6.56%	5.91%
10				6.55%	5.90%
11				3.28%	5.91%
12					5.90%
13					5.91%
14					5.90%
15					5.91%
16					2.95%

For your answer, round to the nearest dollar, do not enter the $ sign, use commas to separate thousands, use a negative sign in front of first number is the cash flow is negative (do not use parenthesis to indicate negative cash flows). For example, if your answer is $3,005.87 then enter 3,006; if your answer is -$1,200.25 then enter -1,200

1. What is today's remaining book value of existing equipment?

2. What is the project's cash flows (initial outlay) at Year 0?

4. What is the incremental Earnings before Interests, Taxes, Depreciation, and Amortization (EBIDTA) in Year 4?

4. What is the net operating profit (NOPAT) + incremental depreciation for year 4 of this replacement project?

Answer 1

	WORKSHEET:
		0	1	2	3	4	5
	Incremental EBITDA		$            4,000	$           4,000	$            4,000	$             4,000	$            4,000
	Incremental depreciation:
	Depreciation of new equipment:
	MACRS 7 Year depreciation rates		14.29%	24.49%	17.49%	12.49%	8.93%
	Depreciation of new equipment:		$            1,172	$           2,008	$            1,434	$             1,024	$                732
	Depreciation of old equipment:
	MACRS 7 Year depreciation rates [From 3rd year]		17.49%	12.49%	8.93%	8.93%	8.93%
	Depreciation of old equipment		$                542	$               387	$                277	$                 277	$                277
	Incremental depreciation		$                630	$           1,621	$            1,157	$                 747	$                455
	Net operating profit [NOI]		$            3,370	$           2,379	$            2,843	$             3,253	$            3,545
	Tax at 30%		$            1,011	$               714	$                853	$                 976	$            1,063
	Net operating profit after tax [NOPAT]		$            2,359	$           1,665	$            1,990	$             2,277	$            2,481
	Add: Incremental depreciation		$                630	$           1,621	$            1,157	$                 747	$                455
	Incremental operating cash flows [OCF]		$            2,989	$           3,286	$            3,147	$             3,024	$            2,937
	ANSWERS:
1]	Remaining book value of existing equipment = 3100-3100*(14.29%+24.49%) =	$               1,898
2]	Cost of the new equipment+installation costs = 8000+200 =	$               8,200
	-After tax sale value of the old equipment = 1000+(1898-1000)*30% =	$               1,269
	-Reduction in NWC	$ 400
	Project's cash flows (initial outlay) at Year 0	$               6,531
3]	EBIT in year 4 [See Worksheet given above]	$               4,000
4]	NOPAT+Incremental depreciation in year 4 [See Worksheet above}	$               3,024