Question

Replacement Analysis 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 $300 for 6 years. Its current book value is $1,800, and it can be sold on an Internet auction site for $4,500 at this time. Thus, the annual depreciation expense is $1,800/6=$300 per year. 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 $7,800, and has an estimated useful life of 6 years with an estimated salvage value of $900. 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 allows for an output expansion, so sales would rise by $2,000 per year; 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 the project cost of capital is 16%.

Should it replace the old steamer? What is the NPV of the project? Round to 2 decimal places.

Answer 1

		Y0	Y1	Y2	Y3	Y4	Y5	Y6	Y7
Increase in Profit			3500	3500	3500	3500	3500	3500		= 2000+1500 from sales and operating expenses savings
Dep rate			20%	32%	19.20%	11.52%	11.52%	5.76%
Dep Value	7800		1560	2496	1497.6	898.56	898.56	449.28		= Yn = Raten*Amount of 7800
PBT			1940	1004	2002.4	2601.44	2601.44	3050.72		= Increasein profit - Dep. Rate
Tax	40%		776	401.6	800.96	1040.576	1040.576	1220.288		= 40%*PBT
PAT			1164	602.4	1201.44	1560.864	1560.864	1830.432		= PBT- Tax
Cash Flow			2724	3098.4	2699.04	2459.424	2459.424	2279.712		= PAT+ Dep.
Workign Capital Investment			2200	0	0	0	0	0		= Increase in Inventory - Increases in Payables
Operational Cash Flow			524	3098.4	2699.04	2459.424	2459.424	2279.712		= Cash Flow-= Change in Working Capital
Saleof Old Machine Cash Flow		3420								= 4500- tax on profit = 4500- 40%*(4500-1800)
Buying New Machine Cash Flow		-7800								= Cash Outflow on buying new machines
Salvage Value									540	= Cash on Sale post tax = 900-900*40%
Receivables Reverted									2200	= Receivables coming back
Total Cash Flow		-4380	524	3098.4	2699.04	2459.424	2459.424	2279.712	2740	= Total Cash Flows on adding each element
NPV		3,912.04								= NPV(16%, Cash Flows)

Hence Steamer should be taken up