Question

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 $350 for 6 years. Its current book value is $2,100, and it can be sold on an Internet auction site for $4,500 at this time. Thus, the annual depreciation expense is $2,100/6=$350 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 $7,900, 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 $1,600 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 13%.

Should it replace the old steamer?

What is the NPV of the project? Do not round intermediate calculations. Round your answer to the nearest dollar.

Answer 1

	0	1	2	3	4	5	6
Increase in sales		2000	2000	2000	2000	2000	2000
Reduction in operating expenses		1600	1600	1600	1600	1600	1600
Incremental depreciation:
Depreciation on side steamer		1580	2528	1517	910	910	455
Depreciation on wood steamer		350	350	350	350	350	350
Incremental depreciation		1230	2178	1167	560	560	105
Incremental NOI		2370	1422	2433	3040	3040	3495
Tax at 40%		948	568.8	973	1216	1216	1398
Incremental NOPAT		1422	853	1460	1824	1824	2097
Incremental depreciation		1230	2178	1167	560	560	105
Incremental OCF		2652	3031	2627	2384	2384	2202
Capital expenditure:
Cost of side steamer	7900
Less: After tax sale price of wood steamer = 4500-(4500-2100)*40% =	3540
Net initial capital expenditure	4360
Increase in NWC (2900-700)	2200						-2200
After tax incremental salvage value = (900-800)*60% =							60
FCF	-6560	2652	3031	2627	2384	2384	4462
PVIF at 13% [PVIF = 1/1.13^n]	1	0.88496	0.78315	0.69305	0.61332	0.54276	0.48032
PV at 13%	-6560	2347	2374	1820	1462	1294	2143
NPV	4881
THE OLD STEAMER SHOULD BE REPLACED AS THE NPV OF THE REPLACEMENT PROJECT IS POSITIVE.