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 $650 for 5 years and $325 for the sixth year. Its current book value is $3,575, and it can be sold on an Internet auction site for $4,150 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 $11,000, and has an estimated useful life of 6 years with an estimated salvage value of $1,100. 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 would allow for an output expansion, so sales would rise by $2,000 per year; even so, 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 its WACC is 16%.

Should it replace the old steamer?

The old steamer _________shouldshould not be replaced.

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

$  

Answer 1

Option 1: Steamer is not replaced:

If the steamer is sold today the gain in sale of asset would be $4150-$3575 = $575

If the steamer is not replaced at continued for next six years the value gained is from the salvage value of $800 whose present value is ($800/(1.16^6)) = $328.

Option 2: Steamer is replaced:

The NPV of the project is negative. (Please see calculations below).

Financially, It doesn't make sense to replace the old steamer.