Question

The Dauten Toy Corporation uses an injection molding machine that was purchased prior to the new tax legislation. This machine is being depreciated on a straight-line basis, and it has 6 years of remaining life. Its current book value is $2,400, and it can be sold for $2,500 at this time. Thus, the annual depreciation expense is $2,400/6 = $400 per year. If the old machine is not replaced, it can be sold for $500 at the end of its useful life. Dauten is offered a replacement machine which has a cost of $10,000, an estimated useful life of 6 years, and an estimated salvage value of $800. The replacement machine is eligible for 100% bonus depreciation at the time of purchase. The replacement machine would permit an output expansion, so sales would rise by $1,000 per year; even so, the new machine's much greater efficiency would cause operating expenses to decline by $1,000 per year. The new machine would require that inventories be increased by $2,000, but accounts payable would simultaneously increase by $800. Dauten's marginal federal-plus-state tax rate is 25%, and its WACC is 11%. What is the NPV of the incremental cash flow stream? Negative value, if any, should be indicated by a minus sign. Round your answer to the nearest cent.

Answer 1

Dauten
100% bonus depreciation at the time of purchase
	depreciation of old machine	400
	book value	2400
	sale price	2500
	gain on sale	100
	tax on gain	25
after tax	cost of new machine	7500	(10000*(1-.25))
less	sale of old machine	2500
add	tax on sale of old machine	25
	working capital()	1200
	initial cash flow at year 0	-6225
year	depreciation	old machine depreciation	change in depreciation
	new	old	new - old
1	0	400	-400
2	0	400	-400
3	0	400	-400
4	0	400	-400
5	0	400	-400
6	0	400	-400
	total increase in earnings=800+1000	1800
incremental cash flow
year	earnings(1-tax)+change in depreciation*Tax
1	1800*(1-.25))-400*.25	1250
2	1800*(1-.25))-400*.25	1250
3	1800*(1-.25))-400*.25	1250
4	1800*(1-.25))-400*.25	1250
5	1800*(1-.25))-400*.25	1250
6	1800*(1-.25))-400*.25+after salvage tax+	2550
	working cap recovery-old salvage value
year	cash flow	pv factor at 11%	pv of cash flow after tax
0	-6225	1	-6225
1	1250	0.909090909	1136.363636
2	1250	0.826446281	1033.057851
3	1250	0.751314801	939.1435011
4	1250	0.683013455	853.7668192
5	1250	0.620921323	776.1516538
6	2550	0.56447393	1439.408522
		NPV (sum of pvafter tax)	($47.11)
		NPV is negative so replacement should not be done