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 $650 for 5 years and $340 for the sixth year. Its current book value is $3,590, and it can be sold on an Internet auction site for $4,200 at this time. 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 $12,200, and has an estimated useful life of 6 years with an estimated salvage value of $1,300. 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 $1,900 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 25%, and the project cost of capital is 11%. What is the NPV of the project? Do not round intermediate calculations. Round your answer to the nearest dollar. $    Should it replace the old steamer?

Answer 1

Statement showing Cash inflow from sale of old machine

Particulars	Amount
Selling price of old machine	4200.00
Book value of old machine	3590.00
Profit	610.00
Tax @ 25%	152.50
Cash inflow from sale of old machine (4200-152.50)	4047.50

Statement showing depreciation

Year	Opening balance	Depreciation Rates	Depreciation (purchase price x Depreciation rates)	Closing Balance
1	12200.00	0.20	2440.00	9760.00
2	9760.00	0.32	3904.00	5856.00
3	5856.00	0.19	2342.40	3513.60
4	3513.60	0.12	1405.44	2108.16
5	2108.16	0.12	1405.44	702.72
6	702.72	0.06	702.72	0.00

Statement showing NPV

Particulars	0	1	2	3	4	5	6	NPV = sum of PV
Cost of Side Steamer 3000	-12200.00
Cash inflow from sale of old equipment	4047.50
WC Requirement (2900-700)	-2200.00
Increase in sales		2000.00	2000.00	2000.00	2000.00	2000.00	2000.00
Savings in cost		1900.00	1900.00	1900.00	1900.00	1900.00	1900.00
Less : Depreciation		2440.00	3904.00	2342.40	1405.44	1405.44	702.72
PBT		1460.00	-4.00	1557.60	2494.56	2494.56	3197.28
Tax @ 25%		365.00	-1.00	389.40	623.64	623.64	799.32
PAT		1095.00	-3.00	1168.20	1870.92	1870.92	2397.96
Add: Depreciation		2440.00	3904.00	2342.40	1405.44	1405.44	702.72
Annual cash flow		3535.00	3901.00	3510.60	3276.36	3276.36	3100.68
Add : Salvage value of Side Steamer 3000 =1300 (1-tax rate) =1300(1-0.25) =1300(0.75) =975							975.00
Total cash flow	-10352.50	3535.00	3901.00	3510.60	3276.36	3276.36	4075.68
PVIF @ 11%	1.0000	0.9009	0.8116	0.7312	0.6587	0.5935	0.5346
PV	-10352.50	3184.68	3166.14	2566.92	2158.24	1944.36	2179.02	4846.87

Thus NPV = $4847

Since NPV is positive one should replace the old steame