Question

1. XYZ Manufacturing Corporation currently has production equipment that has 4 years of remaining life. The equipment was purchased a year ago at a cost of $10,000. The annual depreciation for this machine is $1,800 and its expected salvage value is $1,000. The equipment can be sold today for $8,000. The company has been considering the purchase of a new machine that will replace the existing one. The new equipment costs $15,000 and would increase sales (through increased production) by $2,000 per year and decrease operating costs by $1,000 per year. The equipment falls into the 3-year MACRS class and will be worthless after 4 years. The applicable depreciation rates are 0.33, 0.45, 0.15, and 0.07. The company's tax rate is 40 percent and its cost of capital is 12 percent. By how much would the value of the company change if it accepts the replacement project?

Answer 1

Year	0	1	2	3	4	NPV
Initial outflow
Cost of new machine	-15,000
Realisable value from old machine	8,000
Tax saving on loss (10000-1800)-8000=200*40%	80
Salvage value of the old machine					-1,000
Capital (Outflow)	-6,920	-	-	-	-1,000
Increase in sales		2,000	2,000	2,000	2,000
Saving in op. cost		1,000	1,000	1,000	1,000
Less: Incremental depn		-3,150	-4,950	-450	750
Profit Before Tax		-150	-1,950	2,550	3,750
Tax		-60	-780	1,020	1,500
Profit After Tax		-90	-1,170	1,530	2,250
Add: Depn		3,150	4,950	450	-750
Operating Cash Flow		3,060	3,780	1,980	1,500
Free Cash Flow	-6,920	3,060	3,780	1,980	500
Disc. Fact=1/(1+12%)^n	1.000000	0.892857	0.797194	0.711780	0.635518
Disc. Cash Flow	-6,920	2,732	3,013	1,409	318	553
the value of the company change by $553 if it accepts the replacement project