Question

HL Construction Co. plans to replace one of its manufacturing equipment for a newer more technology-advance one. The new equipment has a purchase price of $8,000 and will be depreciated as a 7-year class for MACRS. Installation costs for the new equipment are $200. It is estimated that this equipment can be sold in 4 years (end of project) for $5,000. This new equipment is more efficient than the existing one and thus savings before taxes using the new equipment are $4,000 a year. Because of the advance technology of new equipment, there will be a reduction in inventory of $400 today and which will be reverted at the end of the project in year 4. This existing equipment was purchased 2 years ago at a base price of $3,000. Installation costs at the time for this old equipment were $100. The existing equipment is considered also 7-year class for MACRS. The existing equipment can be sold today for $1,000 and for $0 in 4 years. The company's marginal tax rate is 30% and the cost of capital is 10%. MACRS Fixed Annual Expense Percentages by Recovery Class Year    3-Year    5-Year    7-Year    10-Year    15-Year 1    33.33%    20.00%    14.29%    10.00%    5.00% 2    44.45%    32.00%    24.49%    18.00%    9.50% 3    14.81%    19.20%    17.49%    14.40%    8.55% 4    7.41%    11.52%    12.49%    11.52%    7.70% 5        11.52%    8.93%    9.22%    6.93% 6        5.76%    8.93%    7.37%    6.23% 7            8.93%    6.55%    5.90% 8            4.45%    6.55%    5.90% 9                6.56%    5.91% 10                6.55%    5.90% 11                3.28%    5.91% 12                    5.90% 13                    5.91% 14                    5.90% 15                    5.91% 16                    2.95% For your answer, round to the nearest dollar, do not enter the $ sign, use commas to separate thousands, use a negative sign in front of first number is the cash flow is negative (do not use parenthesis to indicate negative cash flows). For example, if your answer is $3,005.87 then enter 3,006; if your answer is -$1,200.25 then enter -1,200

what is the incremental net operating profit (NOPAT) for year 4 of this replacement project?

Answer 1

WORKSHEET:
	0	1	2	3	4
Incremental EBITDA		$                 4,000	$                 4,000	$               4,000	$              4,000
Incremental depreciation:
Depreciation of new equipment:
MACRS 7 Year depreciation rates		14.29%	24.49%	17.49%	12.49%
Depreciation of new equipment:		$                 1,172	$                 2,008	$               1,434	$              1,024
Depreciation of old equipment:
MACRS 7 Year depreciation rates [From 3rd year]		17.49%	12.49%	8.93%	8.93%	$        5,638
Depreciation of old equipment		$                     542	$                     387	$                   277	$                  277
Incremental depreciation		$                     630	$                 1,621	$               1,157	$                  747
Net operating profit [NOI]		$                 3,370	$                 2,379	$               2,843	$              3,253
Tax at 30%		$                 1,011	$                     714	$                   853	$                  976
Net operating profit after tax [NOPAT]		$                 2,359	$                 1,665	$               1,990	$              2,277
Add: Incremental depreciation		$                     630	$                 1,621	$               1,157	$                  747
Incremental operating cash flows [OCF]		$                 2,989	$                 3,286	$               3,147	$              3,024
-Capital expenditure [Initial outlay-See calculation below]	$                 6,531
-Reinstatement of NWC					$                  400
+After tax cash flow from sale of new machine [see workings below]					$              4,269
-Tax shield on loss on discarding of old equipment = 3100*13.38%*30% =					$                  124
=Annual total project cash flows	$              (6,531)	$                 2,989	$                 3,286	$               3,147	$              6,769

Incremental net operating profit (NOPAT) for year 4 of this replacement project = $2,277