Question

St. Johns River Shipyard's welding machine is 15 years old, fully depreciated, and has no salvage value. However, even though it is old, it is still functional as originally designed and can be used for quite a while longer. The new welder will cost $83,500 and have an estimated life of 8 years with no salvage value. The new welder will be much more efficient, however, and this enhanced efficiency will increase earnings before depreciation from $29,000 to $58,000 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 40%, and the firm's WACC is 11%. Should the old welder be replaced by the new one?

Older welder (should/should not) be replaced.

What is the NPV of the project? Round your answer to the nearest cent.

Answer 1

(i)	Annual Before depreciation and tax savings =					(58000-29000) =
						29000
	Year	MACRS Rate	Depreciation = Cost x Rate
	0
	1	20.00%	16700
	2	32.00%	26720
	3	19.20%	16032
	4	11.52%	9619.2
	5	11.52%	9619.2
	6	5.76%	4809.6
	Year		1	2	3	4	5	6	7	8
	Annual Before depreciation and tax savings =		29000	29000	29000	29000	29000	29000	29000	29000
Less:	Depreciation		16700	26720	16032	9619.2	9619.2	4809.6	0	0
	Before tax increase in earnings =		12300	2280	12968	19380.8	19380.8	24190.4	29000	29000
Less:	Tax @ 40%		4920	912	5187.2	7752.32	7752.32	9676.16	11600	11600
	Post tax increase in earnings		7380	1368	7780.8	11628.48	11628.48	14514.24	17400	17400
Add:	Depreciation		16700	26720	16032	9619.2	9619.2	4809.6	0	0
	Incremental cashflows		24080	28088	23812.8	21247.68	21247.68	19323.84	17400	17400
	PV Factor @ 11%		0.900901	0.811622	0.731191	0.658731	0.593451	0.534641	0.481658	0.433926
	PV of cashflows		21693.69	22796.85	17411.71	13996.5	12609.46	10331.31	8380.856	7550.321
	Total PV =		114770.7
Less:	Initial Cost		83500
	NPV		31270.72
	As the NPV is positive welder should be replaced.
	NPV =		31270.72