Question

Replacement Analysis

The Everly Equipment Company's flange-lipping machine was purchased 5 years ago for $100,000. It had an expected life of 10 years when it was bought and its remaining depreciation is $10,000 per year for each year of its remaining life. As older flange-lippers are robust and useful machines, this one can be sold for $20,000 at the end of its useful life.

A new high-efficiency digital-controlled flange-lipper can be purchased for $150,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $45,000 per year, although it will not affect sales. At the end of its useful life, the high-efficiency machine is estimated to be worthless. MACRS depreciation will be used, and the machine will be depreciated over its 3-year class life rather than its 5-year economic life, so the applicable depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%.

The old machine can be sold today for $50,000. The firm's tax rate is 35%, and the appropriate cost of capital is 13%.

1. If the new flange-lipper is purchased, what is the amount of the initial cash flow at Year 0? Round your answer to the nearest whole dollar.
   $
2. 
   
3. 
   
4. 
   
5. What are the incremental net cash flows that will occur at the end of Years 1 through 5? Do not round intermediate calculations. Round your answers to the nearest whole dollar.

   CF1	$
   CF2	$
   CF3	$
   CF4	$
   CF5	$

6. 
   
7. What is the NPV of this project? Do not round intermediate calculations. Round your answer to the nearest whole dollar.
   $  
   
   Should Everly replace the flange-lipper?
     

Answer 1

Answer (a):

Old machine was purchased 5 years ago for $100,000. Depreciation per year is $10,000

Hence book value now = 100000 - 5 * 10000 = $50,000

The old machine can be sold today for $50,000.

Hence:

There is no gain and tax impact.

Sale proceeds of old machine net of tax = $50,000

Initial cash flow at Year 0 = -(New machine cost - Sale proceeds of old machine net of tax) = - (150000 -50000) = - $100,000

Initial cash flow at Year 0 = $100,000

Answer (b):

Working:

Answer (c):

NPV of this project = $25,048

Yes,

Everly should replace the flange-lipper. The NPV is positive.

Working: