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 $650 for 5 years and $325 for the sixth year. Its current book value is $3,575, and it can be sold on an Internet auction site for $4,150 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 $11,000, and has an estimated useful life of 6 years with an estimated salvage value of $1,100. 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 would allow for an output expansion, so sales would rise by $2,000 per year; even so, 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 its WACC is 15%.

The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.

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

Answer 1

The characteristics of old and new equipment are given below in attached Image :--

Depriciation per year shown in attached Image :--

As mentioned in question the depreciation of old steamer is $650 for 5 years and 325 for 6th year. The depreciaton of New steamer is computed by per year rate multiply by Acquisition Cost.

If the new steamer replaces old steamer, also increment in Net working Capital, then Initial Outlay will be :--

Outlay = FCInv + NWCInv - Sal₀ + T( Sal₀ - B₀)

where,

FCInv = Investment in new Fixed capital = $11000

NWCInv = Investment in new working capital = $2200 [ new working capital = Increase in Inventory (2900) - Increase Accounts Payable ( 700) ]

Sal₀ = Current Market Value of old steamer= $4150

B₀ = Book Value of old steamer = $3575

T = Tax Rate = 40%

Therefore,

Outlay = 11000 + 2200 - 4150 + 0.4( 4150 - 3575)

= $9280

Now lets compute CashFlows

CashFlow (CF) = (S - C - D) (1 - T) + D

S = Increase In sales per year = $2000

C = Increase in Cash Operation expense = $(- 1500)

Note : As there is Decrese in Operating Expense thereby Making its calculation by adding to Increase in sales per year not subtracting. For Example, lets take 1st year (S- C) = 2000 - (-1500) = 2000 + 1500 = 3500. Same is happening in each year's Increase in Sales and Operating Expense.

(1-T) = (1- Tax Rate) = 0.6

D = New Depriciation per year - Old Depreciation per year

There will be different CF in each year. So, all CF is shown in attached Image below :--

Terminal Value

TNOCF = Sal_T + NCWCInv + T(Sal_T - B_T)

TNOCF = Terminal value after tax cash flow

Sal_T = cash proceed ( salvage value) from sale of fixed capital on termination date = Expected sale price of New steamer - Expected sale price of Old steamer

   = 1100 - 800 = $300

NCWCInv = Investment in new working capital = $2200

T = Tax rate = 40%

B_T = Book value at termination date is ZERO for both steamer = 0

Therefore,

TNOCF = 300 + 2200 - 0.4(300 - 0)

= $2380

NPV =

  

Where,

WACC = 15%

t = per year period

=

Note :  Year 6 CashFlow and Terminal value are at same period so it is divided by same period Factor i.e. (1.15)^6

So, NPV = $1805.23