Question

In: Finance

St. Johns River Shipyard's welding machine is 15 years old, fully depreciated, and has no salvage...

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.

Solutions

Expert Solution

(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

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