Question

Problem 11-13
Replacement Analysis

The Everly Equipment Company's flange-lipping machine was purchased 5 years ago for $100,000. It had an expected life of 10 years when it was bought and its remaining depreciation is $10,000 per year for each year of its remaining life. As older flange-lippers are robust and useful machines, this one can be sold for $20,000 at the end of its useful life.

A new high-efficiency digital-controlled flange-lipper can be purchased for $130,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $45,000 per year, although it will not affect sales. At the end of its useful life, the high-efficiency machine is estimated to be worthless. MACRS depreciation will be used, and the machine will be depreciated over its 3-year class life rather than its 5-year economic life, so the applicable depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%.

The old machine can be sold today for $55,000. The firm's tax rate is 35%, and the appropriate cost of capital is 13%.

1. If the new flange-lipper is purchased, what is the amount of the initial cash flow at Year 0? Round your answer to the nearest whole dollar.
   $
2. 
   
3. 
   
4. 
   
5. What are the incremental net cash flows that will occur at the end of Years 1 through 5? Do not round intermediate calculations. Round your answers to the nearest whole dollar.

   CF1	$
   CF2	$
   CF3	$
   CF4	$
   CF5	$

6. 
   
7. What is the NPV of this project? Do not round intermediate calculations. Round your answer to the nearest whole dollar.
   $
   
   Should Everly replace the flange-lipper?
       -Select-YesNo

Answer 1

Replacement of equiment need to analysed with the help of cash out flow and cash inflow.

a. If old machinery replaced with new machinery, they will adjust the cash flow as given below.

Cost of new machine	130000
Less: sale value of old machine	55000
Intial cash flow of new machin	75000

Therefore after adjusting sales proceeds of old machine initial cost of acquiring new machine at Year - 0 will be $75000.

The incremental cash flow after replacing the old machine will be in the nature of saving on operating cost. though there is no change in sales but there will be change in net profit by $45000 each year.

Year	Incremental cash flow
1	45000
2	45000
3	45000
4	45000
5	45000
Total	225000

NPV of the project will be calculated based on the discountig of future cash flow for today.

The formula for NPV = Cash flow / (1+r)^n

where cash flow stands for cash flow of each year

r stands for rate of discount or cost of capital

n stands for number of year i.e for end of first year 1, for second year 2 and so on till years. The calculation results are as given below.

Year	Cash flow	PV.Factor 13% 1/(1+r)^n	Value
0	-75000	NA	-75000
1	45000	0.884955752	39823.00885
2	45000	0.783146683	35241.60075
3	45000	0.693050162	31187.2573
4	45000	0.613318728	27599.34275
5	45000	0.542759936	24424.19712
		Total	83275

Cash flow analysis after tax and depreciation.

Year	Cash flow	Depreciation	Profit after depreciation	Tax @ 35%	Cash flow after tax plus depreciation	PV.Factor 13%	Final cash flow
0	-75000	0	0	0	0	NA	-75000
1	45000	43329	1671	584.85	44415.15	0.884955752	39305.44248
2	45000	57785	-12785	0	45000	0.783146683	35241.60075
3	45000	19253	25747	9011.45	35988.55	0.693050162	24941.87042
4	45000	9633	35367	12378.45	32621.55	0.613318728	20007.40754
5	45000	0	45000	15750	29250	0.542759936	15875.72813
						NPV	60372

Decision: Replacement of old machinery offers positive cash flow after tax, therefore the project can be accepted