Question

The Woodruff Corporation purchased a piece of equipment three years ago for $233,000. It has an asset depreciation range(ADR) midpoint of 8 years. The old equipment can be sold for $94000. A new piece of equipment can be purchased for $335,500. It also has an ADR of 8 years. Assume the old and new equipment would provide the following operating gains(or losses) over the next six years:

Year New Equipment Old Equipment

1 $78,750 $26,000

2 $76,250 $14,500

3 $68,250 $8,500

4 $59,000 $6,250

5 $51,250 $4,250

6 $44,250 $-8,250

The firm has a 25 percent tax rate and a 9% cost of capital.

1.What is the net cost of the new equipment?

2. What is the present value of incremental benefits?

3. What is the NPV of this replacement decision?

Answer 1

1)

depreciation schedule for old equipment

book value of old equipment =asset value- cummulative dep upto third year

=233000-165896

=67104

gain = sale proceed - book value

=94000-67104

gain on sale of old equipmetn =26896

net cashfflow from sale of old machine =gain- tax on gain

=26896-26896*25%

=20172

net cost of new equipment = purchase price -net cashfflow from sale of old machine

=335500-20172

=315328

2)

present value of net benefits is 236320.96

3) npv = cashinflow-cashoutflows

=236320.97-315328

-79007.03