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 $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.

Gilbert is considering purchasing the Side Steamer 3000, a higher-end steamer, which costs $8,100, 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 $1,500 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 15%. 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

	Cash outflow at Year 0
	Purchase Price			-8100
	Sale of Old machine			4150
	Tax on sale of old machine	(4500-2100)*40%		-960
	Net Working capital	(2900-700)		-2200
				-7110
	Annual Cash flows
	Sales Increase			2000
	Cost decrease			1500
	Increase in pre-tax revenues			3500
	Tax @ 40%			1400
	After-tax revenue increase			2100
	Calculate the Depreciation Tax Savings
			1	2	3	4	5	6
	New		1620	2592	1555.2	933.12	933.12	466.56
	Old		350	350	350	350	350	350
	Change		1270	2242	1205.2	583.12	583.12	116.56
	Depreciation tax savings		508	897	482	233	233	47
	NPV Calculation
			0	1	2	3	4	5	6
	Cash outflow		-7110
	After-tax sales revenue			2100	2100	2100	2100	2100	2100
	Depreciation tax savings			508	897	482	233	233	47
	Working capital recovery								2200
	Salvage Value of new machine								900
	Tax on Salvage value								-360
	Opportunity cost of old machine								-480	800*(1-0.60)
	Project cash flows		-7110	2608	2997	2582	2333	2333	4407
	Discounting factor @ 15%		1	0.869565	0.756144	0.657516	0.571753	0.497177	0.432328
			-7110	2267.826	2266.163	1697.707	1333.9	1159.913	1905.268
	Net Present Value		3520.777
	Since NPV is positive, replacement must be made