Question

Replacement Analysis

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 $600 for 5 years and $330 for the sixth year. Its current book value is $3,330, and it can be sold on an Internet auction site for $4,030 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 $12,200, and has an estimated useful life of 6 years with an estimated salvage value of $1,700. 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 $1,900 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 14%.

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

$  

Should it replace the old steamer?

The old steamer -Select-shouldshould notItem 2 be replaced.

Answer 1

Cash Outflow
cost of new steamer		-12200		Sale proceeds of old steamer	4030
Net investment in working capital	(2900-700)	-2200		Book value of old steamer	3330
after tax sale proceeds =4030-280	4030 -(4030-3330)*(1-.4)	3750		capital gain on disposal	700
total cash outflow		-10650		tax on capital gain =700*40%	280
				after tax sale proceeds =4030-280	3750
Year	cost of new steamer	MACRS rate	annual depreciation on new steamer	annual depreciation on old steamer	incremental depreciation
1	12200	20%	2440	600	1840
2	12200	32%	3904	600	3304
3	12200	19.20%	2342.4	600	1742.4
4	12200	11.52%	1405.44	600	805.44
5	12200	11.52%	1405.44	600	805.44
6	12200	5.76%	702.72	330	372.72
Year	0	1	2	3	4	5	6
total cash outflow	-10650
incremental annual savings =(savings in operating expenses+increase in sales) =(1900+2000)		3900	3900	3900	3900	3900	3900
incremental depreciation		1840	3304	1742.4	805.44	805.44	372.72
incremental operating profit		2060	596	2157.6	3094.56	3094.56	3527.28
less taxes-40%		824	238.4	863.04	1237.824	1237.824	1410.912
after tax profit		1236	357.6	1294.56	1856.736	1856.736	2116.368
add incremental depreciation		1840	3304	1742.4	805.44	805.44	372.72
after tax scrap value of new steamer = (1700)*(1-.4)							1020
recovery of working capital							2200
net operating cash flow	-10650	3076	3661.6	3036.96	2662.176	2662.176	5709.088
present value factor at 14% =1/(1+r)^n r=14%	1	0.877192982	0.769467528	0.674971516	0.592080277	0.519368664	0.45558655
present value of net operating cash flow = net operating cash flow*present value factor	-10650	2698.245614	2817.482302	2049.861496	1576.221904	1382.650793	2600.98369
net present value = sum of present value of net operating cash flow	2475
Yes it should replace the steamer as it results in positive net present value